Section 3856 - Financial Instruments

Applies to all financial instruments except for the following:

• Interests in subsidiaries, entities subject to significant influence, and joint arrangements that are accounted for in accordance with Section 1591, Subsidiaries, Section 3051, Investments, and Section 3056, Interests in Joint Arrangements; however, this Section does apply to a derivative that is based on such an interest.
• Leases (see Section 3065, Leases), although Appendix B of this Section applies to transfers of lease receivables.
• Employer's rights and obligations for employee future benefits and related plan assets (see Section 3462, Employee Future Benefits).
• Insurance contracts, including the cash surrender value of a life insurance policy.
• Investments held by an investment company that are accounted for at fair value in accordance with AcG-18, Investment Companies; however, the disclosure requirements in paragraphs 3856.37-.54 apply to an investment company.
• Contracts and obligations for stock-based compensation to employees and stock-based payments to non-employees (see Section 3870, Stock-based Compensation and Other Stock-based Payments).
• Guarantees, other than guarantees that replace financial liabilities as described in paragraph 3856.A58 (see also AcG-14, Disclosure of Guarantees).
• Contracts based on revenues of a party to the contract.
• Loan commitments (see Section 3280, Contractual Obligations, and Section 3290, Contingencies).
• Contractual arrangements that prevent sale treatment (for example, an option to repurchase transferred receivables).
• Contracts issued by an acquirer (but not the seller) for contingent consideration in a business combination until such time as the contingency is resolved (see Section 1582, Business Combinations, paragraphs .41-.42). This exception applies only to the acquirer (the entity that is accounting for the combination) and not to the seller.

Does not apply to:

• Contracts to buy or sell non-financial items except for:
  • Exchange-traded futures contracts; and
  • Contracts that are designated in a qualifying hedging relationship in accordance with paragraphs 3856.30-.36.
• Non-financial assets and non-financial liabilities; and
• Initial measurement of financial assets acquired or financial liabilities assumed in a transaction when a business is transferred between two enterprises under common control (see Section 3840 Related Party Transactions, paragraph 44).

• Cash;
• Demand and fixed-term deposits;
• Commercial paper, bankers’ acceptances, treasury notes and bills;
• Accounts, notes and loans receivable and payable;
• Bonds and similar debt instruments, both issued and held as investments;
• Common and preferred shares and similar equity instruments, both issued and held as investments; and
• Options, warrants, futures contracts, forward contracts, and swaps.

A contract that creates a financial asset for one entity and a financial liability or equity instrument of another entity.

A contract between related parties³ that creates a financial asset for one entity and a financial liability or equity instrument of another entity.

Any asset that is:

• Cash;
• A contractual right to receive cash or another financial asset from another party;
• A contractual right to exchange financial instruments with another party under conditions that are potentially favourable; or
• An equity instrument of another entity.

The cost incurred by an entity to purchase a right to reacquire its own equity instruments from another party is a deduction from its equity, not a financial asset.

Any liability that is a contractual obligation:

• To deliver cash or another financial asset to another party; or
• To exchange financial instruments with another party under conditions that are potentially unfavourable to the entity

Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

A contract with all three of the following characteristics:

• It’s value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variable (sometimes called the “underlying”), provided in the case of a non-financial variable that the variable is not specific to a party to the contract;
• It requires no initial investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and
• It is settled at a future date.

The amount of the consideration that would be agreed upon in an arm's length transaction between knowledgeable, willing parties who are under no compulsion to act (refer to paragraph 3856.A7 for additional guidance).

For the purposes of applying paragraph 3856.08B, carrying amount is the amount of an item transferred, or cost of services provided, as recorded in the accounts of the transferor, after adjustment, if any, for amortization or impairment in value.

The amount of consideration paid or received as established and agreed to by related parties.

• Except for retractable or mandatorily redeemable shares issued in a tax planning arrangement (RoMRS), which are discussed later in this publication, all financial assets originated or acquired and all financial liabilities issued or assumed in arm’s length transactions are measured initially at fair value⁶.
• Directly attributable transaction costs are added to or deducted from the fair value of those financial instruments that are not measured subsequently at fair value.

  • Directly attributable transaction costs - incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability (Transaction costs include expenditures such as legal fees, reimbursement of the lender's administrative costs and appraisal costs associated with a loan. Transaction costs do not include financing fees, debt premiums or discounts).

• If there is a difference between the consideration paid or received and the fair value of the instrument, the difference should be recognized in net income unless it qualifies as some other type of asset or liability.

(See footnote 7)

Cost

Except as noted in paragraphs3856.08C and 08D (explained below), and for financial assets acquired or financial liabilities assumed in a transaction when a business is transferred between two enterprises under common control and RoMRS, when a financial asset is originated or acquired or a financial liability is issued or assumed in a related party transaction, it is initially measured at cost. Cost is dependent on whether the instrument has repayment terms. When the instrument:

• Has repayment terms (refer to paragraph 3856.A8A for examples), its cost is determined using the undiscounted cash flow(s), excluding interest and dividend payments, of the instrument less any impairment losses previously recognized by the transferor;
• Does not have repayment terms (refer to paragraph 3856.A8B for examples), its cost is determined using the consideration transferred or received by the entity. When the consideration transferred by the entity:
  • Is a financial instrument with repayment terms, the undiscounted cash flow(s), excluding interest and dividend payments, of the instrument transferred as consideration less any impairment losses previously recognized by the transferor is used as cost;
  • Is an asset or liability without repayment terms, the carrying or exchange amount of the consideration transferred is used as cost:
    • The cost of the instrument is the exchange amount of the consideration transferred or received when:
      • The transaction is in the normal course of operations; or
      • The transaction is not in the normal course of operations and
        • The transaction is a monetary transaction or a non-monetary transaction that has commercial substance;
        • The change in the ownership interest in the related financial item transferred is substantive; and
        • The amount of consideration paid or received is established and agreed to by related parties and is supported by independent evidence.
    • Otherwise, the cost of the instrument is the carrying amount of the consideration transferred or received.

Fair Value

As per paragraph 3856.08C, the following financial instruments originated or acquired in a related party transaction are measured at fair value without any adjustments:

• Investments in equity instruments or debt instruments quoted in an active market;
• Debt instruments when the inputs significant to the determination of fair value are observable, either directly or indirectly; and
• Derivative contracts.

Variable Portion

As per paragraph 3856.08D, except for related party indexed liabilities to which paragraph 3856.14A applies, an entity does not measure the variable or contingent portion of a related party financial instrument.

Instead, the terms of the instrument are disclosed and the instrument is remeasured at fair value once the contingency or variability is resolved, with any gain or loss recognized in net income.

Gain or Loss

Except for RoMRS, on initial measurement, when a related party transaction includes a financial instrument that is in the normal course of operations, or is not in the normal course of operations and:

• The transaction is a monetary or non- monetary transaction that has commercial substance;
• The change in the ownership interests in the items transferred is substantive; and
• The transaction amounts for each of the elements in the transaction are supported by independent evidence,

In that situation, any gain or loss resulting from initial recognition is included in net income, unless another Section requires alternative treatment. Otherwise, any difference resulting from the transaction is included in equity.

The issuer of a financial liability that is indexed to a measure of the entity’s financial performance or to changes in the value of the entity’s equity, initially measures the instrument in accordance with the requirements for arm’s length transactions or related party transactions, which are outlined above.

In an arm’s length transaction, if an instrument has both liability and equity components, such as is the case with convertible debt or when warrants or options are issued with and detachable from a liability, an accounting policy choice exists as there are two acceptable methods for measurement of the liability and equity elements on initial measurement:

• The equity component is measured at zero. As a result, the entire proceeds are allocated to the liability component; or
• The less easily measurable component is allocated to the residual amount after deducting from the entire proceeds of the issue the amount separately determined for the component that is more easily measurable.

Similarly, in a related party transaction, if an instrument has both liability and equity components, an accounting policy choice exists as there are two acceptable methods for measurement of the liability and equity elements on initial measurement:

• The equity component is measured at zero. As a result, the entire proceeds are allocated to the liability component; or
• The equity component is allocated the residual amount after deducting from the entire proceeds of the issue the amount separately determined for the liability component measured in accordance with paragraph 3856.08(a).

(See footnote 11)

The following instruments are classified as equity on initial recognition:

• Partnership interests and certain types of shares in co-operative organizations that provide for payments to the holder of a pro rata share of the residual equity of the issuer in the event of specific events like liquidation or death of the holder.

A retractable or mandatorily redeemable share, other than RoMRS, is classified as a liability unless all of the following criteria are met:

• The redeemable shares are the most subordinated of all equity instruments issued by the enterprise;
• The redemption feature is extended to 100 percent of the common shares and the basis for determination of the redemption price is the same for all shares;
• The shares have no preferential rights relative to other classes of shares of the enterprise that have the same degree of subordination; and
• The redemption event is the same for all the shares subject to the redemption feature.

Initial Classification

Per paragraph 3856.23, when an entity issues retractable or mandatorily redeemable shares in a tax planning arrangement¹² (RoMRS), it may choose to present those shares at par, stated or assigned value as a separate line item in the equity section of the Balance Sheet only when ALL of the following conditions are met:

• Control (refer to Section 1591, Subsidiaries, for guidance on determining control) of the entity issuing the RoMRS is retained by the individual shareholder¹³ receiving the shares in the arrangement;
  • If an entity issues RoMRS to two or more related parties, an assessment of which related party, if any, controls the entity (control assessment is performed in accordance with Section 1591) is needed to determine whether control of the entity is retained by the shareholder receiving the shares in the arrangement.
• In the arrangement, either:
  • No consideration is received by the entity issuing the RoMRS; or
  • Only shares of the entity issuing the RoMRS are exchanged; and
• No other written or oral arrangement (such as a redemption schedule) exists, that gives the holder of the shares the contractual right to require the entity to redeem the shares on a fixed or determinable date or within a fixed or determinable period.
  
  If any of the above conditions are not met for any or all of the shares issued, the issuer must classify those shares as a financial liability, present them separately on the Balance Sheet and measure them at their redemption amount. Any resulting adjustment is recognized in either retained earnings or a separate component of equity.

An entity can choose to initially present RoMRS as a financial liability, even if the criteria for equity classification outlined above are met. However, once RoMRS have been classified as a financial lability they cannot subsequently be reclassified as equity.

Subsequent Classification

• RoMRS initially classified as equity, are not subsequently reclassified to liability unless an event or transaction occurs that indicates the conditions for equity classification are no longer met. Examples of indicators that equity classification may no longer be met include, but are not restricted to:
  • The death of the holder of the RoMRS;
  • A change in ownership of the entity that may affect the assessment of control of the entity that issued the RoMRS;
  • A change in the shareholders' agreement that may affect the assessment of control of the entity that issued the RoMRS;
  • Redemption of some or all of the RoMRS;
  • The creation of a written or oral arrangement that gives the holder of the RoMRS the right to require the entity to redeem the shares within a fixed or determinable period; or
  • Modifications to the RoMRS.
• When an event or transaction gives rise to a reclassification of RoMRS from equity to a financial liability, the entity measures the reclassified shares at the redemption amount on that date and presents them separately on the Balance Sheet. Any resulting adjustment is recorded in retained earnings or a separate component of equity in accordance with Section 3251, Equity.
• Once RoMRS have been classified as a financial lability they cannot subsequently be reclassified as equity.
• RoMRS classified as a financial liability are not permitted to use the callable debt presentation outlined in the illustrative example in Section 1510, Current Assets and Current Liabilities.