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Financial instruments - is the devil really so bad? Prologue.

Another year is coming to an end, so for most companies and accounting departments the time of hard work and preparations to close the books has begun. On the basis of information received from our clients and inquiries addressed to us during the training courses conducted for financial and accounting departments, we have gathered a group of issues which, during the period of preparation of financial statements, are of constant interest and do not lose anything of their relevance. We have already discussed most of them for you on our blog; these are issues related to, among others: leasing, including IFRS 16 Leasing, investments in real estate IAS 40, the revaulation model according to IAS 16 or revenue recognition according to IFRS 15. In the following sequences we will present issues related to the creation and presentation of provisions (IAS 37) and the issue of residual value and depreciation according to IAS 16. Nevertheless, the greatest emphasis will be placed on the analysis of financial instruments.

Why are financial instruments so important?

In the world of accountants and auditors, various myths about financial instruments are present. First of all, however, the unwritten principle seems to be the desire to push their subject as far away from each other as possible. It is like saying that "surely financial instruments do not concern me" or "surely there are no financial instruments in our small company".

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In fact, the issue of financial instruments concerns entrepreneurs as often as the tangible fixed assets or capital that appear in almost every company. So if financial instruments occur in practice and are an important part of economic events, why should they be treated with less attention than other balance sheet items and left without proper valuation and presentation in the financial statements?

Financial instruments under a magnifying glass

Financial instruments include traditional, basic instruments such as bonds or shares. However, in economic trading, we also deal with more complex instruments, which can include: interest rate swaps or term contracts. Most companies have financial instruments, therefore we have decided to offer you a series of articles in which we will indicate how - from a practical point of view - financial instruments should be identified, properly priced and presented. We will be assisted not only by the provisions of the Accounting Act (hereinafter: AoA) or the Regulation on Financial Instruments (hereinafter: RFI), but also, and perhaps most importantly, by the International Financial Reporting Standards (IFRS) - mainly including IFRS 9, but also IFRS 7, IAS 32 and IAS 39.

Historically, it was in 1995 that IAS 32 was published, which contains disclosure requirements for financial instruments. The second phase of work on the issue of instruments, including issues related to their recognition and valuation, was crowned with IAS 39, 3 years later. The next international standards in the scope of financial instruments did not appear until 2005, when the Council published IFRS 7, and then again in 2014, when the complete IFRS 9 standard was published. But we will talk about all this soon, in the first half of 2020 in fact.

Now, as I have already mentioned at the beginning, we will focus on the recognition and recognition of provisions, liabilities (including contingent liabilities), passive cost settlements (based on IAS 37) and the depreciation of fixed assets taking their residual value into account (IAS 16).

In the first of these subjects, the following very often occurs:

  • not recognising provisions at all (incorrect approach to a past event requiring consideration of provisioning) or,
  • the incorrect classification of provisions and the incorrect presentation in the balance sheet.

In the case of the valuation of property, plant and equipment, the following seem doubtful:

  • depreciation method,
  • the use of a residual value or,
  • to determine the appropriate depreciation rate for the fixed asset and its components.

If you are interested in the correct presentation of the above mentioned issues in the financial statements, I invite you to closely follow the subsequent entries on our blog.

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