CFM23094 - New UK GAAP: FRS 105: financial instruments: recognition & measurement

For those entities applying FRS 105 with an accounting period beginning on or after 1 January 2016.

Initial recognition

On initial recognition a financial asset or financial liability is measured at the transaction price (which includes transaction costs where material). Where transaction costs are not material they are recognised immediately as an expense in profit or loss.

The only exception to this initial measurement is if the arrangement represents a financing transaction for the purchase of inventory, property, plant and equipment, investment property or the sale of goods or services with settlement deferred beyond normal credit terms. In that case, the financial asset or liability is initially measured at the cash price available on the date of the transaction.

For example, a micro-entity sells goods to a customer for £100 with a deferred settlement of one year. The same item would normally be sold for £90 on 14 day settlement terms. The micro-entity should initially measure its trade debtor at £90.

Subsequent measurement

A micro-entity’s financial instruments are subsequently measured as follows:

  • the amount initially recognised;
  • plus the cumulative interest income or expense recognised in profit and loss to date;
  • minus all repayments of principal and interest to date; and
  • minus (for financial assets) any reduction for impairment or uncollectability.

Impairments under FRS 105 are covered at CFM23095.

There are two exceptions:

  • Investments in preference or ordinary shares and investments in subsidiaries, associates and interests in jointly controlled entities are measured at cost less impairment.
  • The transaction price of a derivative, plus any transaction costs not immediately recognised in profit or loss, and less any impairment losses, is allocated to the profit or loss over the term of the contract on a straight-line basis, unless another basis of allocation is more appropriate.

Allocation of interest income or expense

Total interest income or expense is the difference between the initial transaction price and the total amount of subsequent contractual receipts or payments, excluding transaction costs.

Under FRS 105, Section 9 the total interest income or expense is allocated over the term of the contract as follows:

  • For deferred settlement the total interest income or expense is allocated on a straight-line basis over the term of the contract.
  • For all other cases the interest income or expense is allocated at a constant rate on the financial instruments carrying amount excluding transaction costs not yet recognised in profit or loss. The rate is normally the contractual rate of interest and may be fixed or variable.

Transaction costs

Transaction costs not immediately recognised in profit or loss are recognised in profit or loss on a straight-line basis over the term of the contract.

Example - Measurement of a loan liability

An entity receives a loan of £1,000 on 1 January 20X0. Arrangement fees total £50. The contractual interest rate is 5% payable annually in arrears on 31 December. The loan is repayable after two years. The entity’s annual reporting period ends on 31 December.

The entity determines that the loan arrangement fees (transaction costs) are material and on 1 January 20X0 recognises the loan at its transaction price of £1,000 less the transaction costs of £50. The transactions costs of £50 are recognised in the profit and loss account on a straight-line basis over two years, ie £25 each year.

The carrying value of the loan is as follows:

Year Carrying amount at 1 Jan Interest at 5% Transaction costs in profit or loss Cash payments Carrying amount at 31 Dec
  (£) (£) (£) (£) (£)
20X0 (950) (50) (25) 50 (975)
20X1 (975) (50) (25) 1050 zero