CFM16240 - Accounting for financial instruments: IAS 32 and IAS 39: measurement of financial liabilities

Initial and subsequent measurement of financial liabilities

Initial measurement

When a financial liability is recognised initially, a company must measure it at its fair value plus, in the case of a financial liability not at fair value through profit or loss (FVTPL), transaction costs that are directly attributable to the acquisition or issue of the financial liability.

Identical considerations relating to the meaning of fair value apply to financial liabilities as to assets ( CFM16215a). The fair value of a financial liability with a demand feature, such as a demand deposit, is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid.

Example

On 1 March 2007, a company overdraws its current account with the bank by £400,000. The overdraft is repayable on demand, so the fair value of the liability is £400,000. If the bank agrees with the company that it will refrain from demanding any repayment of the overdraft for 12 months, the company must calculate the net present value of its obligation to repay £400,000 on 1 March 2008. If the overdraft carries interest at a commercial rate, the fair value of the liability will still be £400,000.

But if the borrowing was interest-free (as might happen if the company had borrowed intra-group, rather than from a bank), the company would initially recognise a net present value lower than the amount borrowed, if the difference was material.

Subsequent measurement

After initial recognition, the company must measure all financial liabilities at amortised cost using the effective interest method, except for:

• financial liabilities at fair value through profit and loss (FVTPL). Most such liabilities, including derivatives that are liabilities and loan commitments that are either designated as FVTPL or can be settled in cash are measured at fair value.
• financial liabilities that arise when a transfer of a financial asset does not qualify for derecognition or when the continuing involvement approach applies (see CFM16255).
• Financial guarantee contracts which shall be measured at the higher of either the amount at initial recognition (less amortisation under IAS 18) or the amount determined under IAS 37; and
• Commitments to provide loans at below market rates, in which case they are measured at the higher of the amount at initial recognition (less amortisation under IAS 18) or the amount determined under IAS 37.

Financial liabilities that are designated as hedged items are subject to measurement under the hedge accounting requirements ( CFM16265).