ACCA FR · Chapter 7
Financial instruments MCQs with Answers
10 multiple-choice questions on Financial instruments for ACCA FR Financial Reporting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Under IFRS 9, how should an investment in a bond be measured if it is held in a business model whose objective is to collect contractual cash flows, and those cash flows are solely payments of principal and interest?
- A) At amortised cost
- B) At fair value through profit or loss
- C) At fair value through other comprehensive income, with no recycling
- D) At cost less impairment, with no interest recognised
Show answer & explanation
Answer: A) At amortised cost
A debt instrument that passes both the business model test (held to collect contractual cash flows) and the contractual cash flow characteristics test (solely payments of principal and interest) is measured at amortised cost using the effective interest method. If the business model is to both collect and sell, FVOCI is used. Otherwise the default is FVTPL.
Question 2
On 1 January Pipit Co issued loan notes with a nominal value of $5,000,000 and received net proceeds of $4,800,000. The coupon is 4% a year, paid on 31 December, and the effective interest rate is 6%. The notes are carried at amortised cost. What is the carrying amount of the liability at 31 December of the first year?
- A) $4,800,000
- B) $5,000,000
- C) $5,088,000
- D) $4,888,000
Show answer & explanation
Answer: D) $4,888,000
Amortised cost: opening $4,800,000 + finance cost at the effective rate ($4,800,000 x 6% = $288,000) - coupon paid ($5,000,000 x 4% = $200,000) = $4,888,000. The liability increases towards the redemption amount as the discount and issue costs are charged through the effective interest rate.
Question 3
On 1 January Linnet Co issued $10,000,000 of 3% loan notes at par, incurring issue costs of $400,000. The notes will be redeemed at a premium, giving an effective interest rate of 7.2%. What finance cost should be recognised in profit or loss for the first year?
- A) $691,200
- B) $300,000
- C) $720,000
- D) $391,200
Show answer & explanation
Answer: A) $691,200
The liability is first recognised net of issue costs: $10,000,000 - $400,000 = $9,600,000. Finance cost = $9,600,000 x 7.2% = $691,200. Only $300,000 is paid in cash. The difference of $391,200 increases the carrying amount, which builds up the redemption premium and spreads the issue costs.
Question 4
Under IFRS 9, how is an investment in equity shares of another company measured after initial recognition, if it is not held for trading?
- A) At amortised cost using the effective interest method
- B) At cost, unless the shares are listed
- C) At fair value through OCI, with gains recycled to profit or loss on disposal
- D) At fair value through profit or loss, unless an irrevocable election is made on initial recognition to use fair value through other comprehensive income
Show answer & explanation
Answer: D) At fair value through profit or loss, unless an irrevocable election is made on initial recognition to use fair value through other comprehensive income
Equity investments do not pass the solely payments of principal and interest test, so they cannot be held at amortised cost. The default is FVTPL. For equity investments not held for trading, an entity may irrevocably elect on initial recognition to use FVOCI. Gains and losses then stay in OCI and are never recycled, although dividends are still recognised in profit or loss.
Question 5
Bittern Co bought 100,000 shares in a listed company for $3.00 each, paying transaction costs of $6,000. The shares are held for trading. At the year end their market price was $3.40. What is the net effect on profit or loss for the year?
- A) Gain of $34,000
- B) Gain of $40,000
- C) Nil; the fair value gain is recognised in other comprehensive income
- D) Loss of $6,000, with the fair value gain taken to OCI
Show answer & explanation
Answer: A) Gain of $34,000
Investments held for trading are measured at FVTPL. They are first recognised at fair value (100,000 x $3.00 = $300,000), and transaction costs of $6,000 are expensed immediately. Fair value gain = 100,000 x ($3.40 - $3.00) = $40,000. Net effect = $40,000 - $6,000 = $34,000.
Question 6
Shrike Co holds an equity investment for which it made the irrevocable FVOCI election under IFRS 9. It sells the investment at a price above its last carrying amount. What happens to the cumulative fair value gains previously recognised in OCI?
- A) They are reclassified (recycled) to profit or loss on disposal
- B) They stay in equity and are not reclassified to profit or loss, though they may be transferred within equity to retained earnings
- C) They are reversed and the whole gain since purchase is recognised in profit or loss
- D) They are deducted from the sale proceeds when the profit on disposal is calculated
Show answer & explanation
Answer: B) They stay in equity and are not reclassified to profit or loss, though they may be transferred within equity to retained earnings
For equity investments designated at FVOCI, IFRS 9 forbids recycling the gains in OCI to profit or loss, even on disposal. The cumulative amount may be transferred within equity, usually to retained earnings. Recycling does apply to debt instruments measured at FVOCI.
Question 7
On 1 January Kite Co issued $2,000,000 of 5% convertible loan notes at par. Interest is paid annually in arrears, and the notes are redeemable at par after 3 years or convertible into equity shares. Similar debt without the conversion option would carry interest of 8%. What amount should be recognised in equity for the conversion option on issue? (Use unrounded discount factors and round your final answer to the nearest dollar.)
- A) $1,845,374
- B) Nil; the whole instrument is a financial liability
- C) $180,000
- D) $154,626
Show answer & explanation
Answer: D) $154,626
IAS 32 splits a convertible instrument into its liability and equity components. Liability = PV at 8% of the interest ($100,000 a year for 3 years) plus the $2,000,000 redemption = $1,845,374. Equity is the residual: $2,000,000 - $1,845,374 = $154,626. Figures are calculated with unrounded discount factors and then rounded to the nearest dollar.
Question 8
On 1 January Kite Co issued $2,000,000 of 5% convertible loan notes at par, redeemable at par after 3 years. The initial liability component was $1,845,374. The effective rate is 8% and annual interest of $100,000 is paid in arrears. What is the carrying amount of the liability component at the end of the first year? (Round to the nearest dollar.)
- A) $1,945,374
- B) $1,845,374
- C) $1,893,004
- D) $1,993,004
Show answer & explanation
Answer: C) $1,893,004
Finance cost = $1,845,374 x 8% = $147,630. Closing liability = $1,845,374 + $147,630 - interest paid $100,000 = $1,893,004. The equity component is not remeasured. The liability builds up to $2,000,000 by the redemption date.
Question 9
Under IAS 32, which of the following should be classified as a financial liability by the issuer?
- A) Preference shares that must be redeemed for cash on a fixed future date
- B) Ordinary shares
- C) Irredeemable preference shares on which dividends are paid at the directors' discretion
- D) Share warrants giving the holder a right to buy a fixed number of shares for a fixed amount of cash
Show answer & explanation
Answer: A) Preference shares that must be redeemed for cash on a fixed future date
A financial liability involves a contractual obligation to deliver cash or another financial asset. Mandatorily redeemable preference shares create that obligation, so they are liabilities and their dividends are finance costs. Ordinary shares, discretionary irredeemable preference shares and 'fixed for fixed' warrants are equity instruments.
Question 10
On 1 January Siskin Co bought a bond with a nominal value of $1,000,000 for $950,000, including transaction costs. The coupon is 6%, received annually on 31 December, and the effective interest rate is 7.25%. The bond is held at amortised cost. What interest income and closing carrying amount should be reported for the first year?
- A) Interest income $60,000; carrying amount $950,000
- B) Interest income $72,500; carrying amount $962,500
- C) Interest income $68,875; carrying amount $958,875
- D) Interest income $68,875; carrying amount $1,000,000
Show answer & explanation
Answer: C) Interest income $68,875; carrying amount $958,875
Interest income is calculated at the effective rate on the opening amortised cost: $950,000 x 7.25% = $68,875. Cash received = $1,000,000 x 6% = $60,000. Closing amortised cost = $950,000 + $68,875 - $60,000 = $958,875.