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This Memorandum is prepared to discuss and outline the accounting requirements and accounting treatments for the investment in debt instruments in the books of accounts. Raising finance through issue of debt instruments and investing funds in the long term debts requires some specific compliance in the books of accounts in accordance with the respective accounting and reporting standards.
Financial instruments are some legal documents of investments or obligations, which gives the holder the right to receive a return arising from such investment and to receive back the principal amount on transfer or repurchase by the issuer. On the other hand, the issuer of such document is liable to pay a certain contractual payments or a return to the holder and to pay back the principle amount on repurchase or maturity of the specified term. AASB9 deals with the classification, accounting and presentation of such assets and liabilities in the books of accounts.
To define an investment instrument a debt instrument or an asset, there are two types of test, one is the business model test and the other is the cash flow characteristic test. If an investment satisfies the conditions of these two tests then the investment can be defined as an asset in debt instruments. The business model test requires the investment to be made with an intention of receiving a periodic cash flow. It implies there will be a fixed periodic return from the investment. On the other hand, the cash flow characteristic test requires that the contractual terms of the instruments specifies the date of the cash flows or the dates of the interest and principle payments. In case of Wakefield Limited, there is an investment proposal of $1,00,000 in a debt instrument of five years which is due to be matured in next three years and the instruments pays an interest of 5%. Therefore, the proposed debt instrument satisfies all the two tests as per the AASB9. Hence, it can be identified as a financial asset in the books of the Wakefield Limited.
Financial assets or debt instruments are initially recognized in the books of accounts at costs or at the actual amount paid for acquisition of such investment. As per the guidelines of the IFRS9 and AASB9, subsequent to the initial recognition of the debt instruments as a financial asset, its value needs to be restated to its current market price. Hence, subsequent to the initial recognition of the debt instrument it is measured at Fair value or net realizable value applying best assumptions and techniques of fair valuation as per IAS 39.
The face value of the debt instrument is $1,00,000, if an amount greater than or less than the face value of the debt instrument is paid for acquisition of the instrument, then the excess or less amount paid in acquisition is to be treated as a foreseeable income or loss. the loss or gain is not recorded at the time of investment rather it is recorded as the actual loss or gain on sale or maturity of the debt instrument. If there is any premium or excess amount paid and it is indeed to hold the instrument till the maturity, then the excess amount paid is recognized and amortized on a periodical basis.
Debt instrument can be purchased either to hold as an investment with an intention of receiving the contractual cash flows or it can be purchased for resale. AASB9 classifies such investment in financial assets, depending on the intention of the purchase of such assets and its cash flow characteristics. As per IFRS9 and AASB9, if such assets are purchased for resale, the investment cannot be treated as a financial asset and it needs to be treated as a trading assets. The difference between the purchase price and the sales price of the debt instrument is treated as the trading gain or trading loss. On the other hand, if such debt instrument is purchased for holding and with an intention of receiving periodic contractual cash flows then, it is treated as a financial asset.
From the discussion and analysis, it can be concluded that, nature and intention of purchase of debt instrument must be defined which identifies the class of the investment and helps in proper accounting treatment in the books of accounts. AASB9 should be followed for guidelines and accounting treatment requirements. Such investment must be recognized in the books of accounts at its acquisition cost initially, and subsequently it should be measured at its fair value.
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