## Learning Outcomes

- Calculate amortised cost using the effective interest method for financial assets and liabilities.
- Distinguish coupon cash flows from effective finance income or finance cost.
- Identify when fair value gains and losses are recognised in profit or loss or OCI.
- Account for equity investments measured at fair value under IFRS 9.
- Explain the treatment of transaction costs in later measurement.
- Calculate basic gains or losses on derecognition of financial assets and financial liabilities.

## ACCA Financial Reporting (FR) Syllabus

This area of ACCA FR tests whether you can apply IFRS 9 measurement rules after initial recognition. Exam questions often use short scenarios with loan notes, discounts, issue costs, redemption premiums, fair value changes, or market index movements. You must be able to calculate carrying amounts quickly and identify the correct statement for gains, losses, finance income, and finance costs.

- Apply the effective interest method to debt assets held at amortised cost.
- Apply the effective interest method to financial liabilities measured at amortised cost.
- Calculate carrying amounts after coupon payments, issue costs, discounts, and premiums.
- Identify default treatment for equity investments: fair value with gains and losses in profit or loss unless an FVOCI election is made.
- Calculate fair value gains or losses for FVTPL assets.
- Explain how transaction costs affect initial and later measurement.
- Recognise gains or losses when financial assets or liabilities are derecognised.
- Avoid confusing fair value with fair value less costs to sell.

## Test Your Knowledge

\_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision.\_1. A loan asset is bought for $500,000, has a principal amount of $550,000, pays 6% interest on principal, and has an effective interest rate of 8%. What is the carrying amount after one year? 2. A $20 million loan liability is issued with issue costs of $500,000. Coupon interest is 5% and the effective interest rate is 10%. What finance cost is charged in year one? 3. In the absence of an FVOCI election, where are fair value changes on an equity investment recognised? 4. A FVTPL investment has a carrying amount of $12.5 million when a market index is 1,200. The index rises to 1,296. What is the fair value gain? 5. When is a financial liability derecognised?

## Introduction

Subsequent measurement means accounting for a financial instrument after it has first been recognised. In ACCA FR, the main issue is usually numerical: a loan note may have been issued at a discount, bought at a premium, or have issue costs attached. The exam then asks for the carrying amount, finance income, finance cost, or fair value gain.

IFRS 9 uses different later measurement categories. Some instruments are measured at amortised cost using the effective interest method. Others are remeasured to fair value, with gains and losses usually going to profit or loss unless a specific OCI treatment applies.

> **Key Term: Subsequent measurement**
> The measurement of a financial asset or financial liability after it has been initially recognised in the financial statements.

### Amortised cost and the effective interest method

Amortised cost is most often tested through loan assets and loan liabilities. The key idea is that the carrying amount is updated each period using the effective interest rate, not merely the coupon rate.

> **Key Term: Amortised cost**
> A measurement basis that starts with the initial carrying amount and adjusts it for repayments, effective interest, cash received or paid, and, for assets, any impairment allowance.

The effective interest method spreads total finance income or finance cost over the expected life of the instrument. It deals with discounts, premiums, issue costs, and redemption premiums by building them into one effective rate.

> **Key Term: Effective interest rate**
> The rate that exactly discounts estimated future cash receipts or payments over the expected life of a financial instrument to its carrying amount.

For an asset measured at amortised cost, the usual working is:

$$
\text{Closing carrying amount} =
\text{Opening carrying amount}
+
\text{Finance income}
-
\text{Cash interest received}
-
\text{Principal repayments}
$$

For a liability measured at amortised cost, the usual working is:

$$
\text{Closing carrying amount} =
\text{Opening carrying amount}
+
\text{Finance cost}
-
\text{Cash interest paid}
-
\text{Principal repayments}
$$

The finance income or finance cost is calculated using the effective interest rate on the opening carrying amount:

$$
\text{Effective finance income or cost} =
\text{Opening carrying amount}
\times
\text{Effective interest rate}
$$

The coupon cash flow is based on the nominal or principal amount, unless the question states another basis:

$$
\text{Coupon cash flow} =
\text{Principal amount}
\times
\text{Coupon rate}
$$

These two figures are often different. That difference causes the carrying amount to move towards the amount receivable or payable at maturity.

> **Test Tip:**
> In effective interest questions, set up a simple three-line working: opening balance, effective interest, cash paid or received. Do not use the coupon rate to calculate finance income or finance cost unless it is also the effective rate.

Consider a debt investment bought for $500,000. It has a principal amount of $550,000, pays 6% annual interest in arrears, and has an effective interest rate of 8%. The annual cash interest is $33,000, calculated as $550,000 × 6%. The year one effective finance income is $40,000, calculated as $500,000 × 8%.

The carrying amount at the end of year one is therefore:

$$
500{,}000 + 40{,}000 - 33{,}000 = 507{,}000
$$

In year two, the effective finance income is based on the new carrying amount:

$$
507{,}000 \times 8\% = 40{,}560
$$

The carrying amount at the end of year two is:

$$
507{,}000 + 40{,}560 - 33{,}000 = 514{,}560
$$

This is a classic ACCA FR pattern. The asset was bought below its principal amount, so its carrying amount increases over time as the discount unwinds.

The same logic applies to financial liabilities. Suppose a 5% loan note with a face value of $20 million is issued, and direct issue costs are $500,000. If the liability is not measured at FVTPL, the issue costs reduce the initial carrying amount. The opening liability is therefore $19.5 million. If the effective interest rate is 10%, the year one finance cost is $1.95 million. The cash coupon is $1 million, being 5% of $20 million.

Closing liability after year one:

$$
19.5m + 1.95m - 1.0m = 20.45m
$$

Year two finance cost:

$$
20.45m \times 10\% = 2.045m
$$

Closing liability after year two:

$$
20.45m + 2.045m - 1.0m = 21.495m
$$

> **Exam Warning:**
> Issue costs on a financial liability measured at amortised cost are not expensed immediately. They reduce the initial carrying amount and are then spread through the effective interest method.

### Discounts, premiums, and transaction costs

A financial asset measured at amortised cost is initially recorded at fair value plus directly attributable transaction costs. After that, the effective interest method unwinds any discount or premium.

> **Key Term: Transaction costs**
> Incremental costs directly attributable to acquiring, issuing, or disposing of a financial asset or financial liability.

Assume a company buys a five-year loan note with a par value of $7 million at a 12% discount. The initial carrying amount is:

$$
7.0m \times 88\% = 6.16m
$$

The loan note pays a 5% coupon and has an effective interest rate of 7%. Annual cash interest is:

$$
7.0m \times 5\% = 0.35m
$$

Year one finance income:

$$
6.16m \times 7\% = 0.431m
$$

Closing carrying amount after year one:

$$
6.16m + 0.431m - 0.35m = 6.241m
$$

Year two finance income:

$$
6.241m \times 7\% = 0.437m
$$

So, for the second year, finance income reported in profit or loss is about $437,000.

This shows why the effective rate matters. The company receives only $350,000 cash interest each year, but it reports higher finance income because it bought the instrument at a discount and will recover more over its life.

For assets or liabilities measured at FVTPL, transaction costs are normally expensed as incurred. They are not added to the carrying amount. For instruments not at FVTPL, directly attributable transaction costs are included in the initial carrying amount, then reflected through the effective interest method.

Later fair value measurement is based on fair value at the reporting date, not fair value plus or minus disposal costs. This is a frequent exam trap.

> **Exam Warning:**
> Do not deduct selling costs when measuring a financial asset at fair value under IFRS 9. Fair value is not the same as fair value less costs to sell.

### Fair value changes under IFRS 9

Fair value measurement is used when IFRS 9 requires or permits an instrument to be measured at fair value. For ACCA FR, the main categories to recognise are FVTPL and FVOCI.

> **Key Term: Fair value**
> The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
>
> **Key Term: FVTPL**
> Fair value through profit or loss; a measurement category where fair value gains and losses are recognised in profit or loss.
>
> **Key Term: FVOCI**
> Fair value through OCI; a measurement category where certain fair value gains and losses are recognised in OCI rather than profit or loss.

For equity investments, IFRS 9 normally requires fair value measurement. In the absence of an election at initial recognition, fair value changes go to profit or loss. This is a simple but common objective test point.

So, if the question says an entity holds an investment in shares and gives no FVOCI election, the answer is:

- measure at fair value; and
- recognise fair value gains and losses in profit or loss.

For a FVTPL asset, the carrying amount at the reporting date is its fair value. Any movement from the previous carrying amount is a gain or loss in profit or loss.

For example, a company has FVTPL financial assets with a carrying amount of $12.5 million. Their value moves directly with a market index. The index was 1,200 at the start of the year and 1,296 at the reporting date.

The new fair value is:

$$
12.5m \times \frac{1{,}296}{1{,}200} = 13.5m
$$

The fair value gain is:

$$
13.5m - 12.5m = 1.0m
$$

This $1.0 million gain is recognised in profit or loss.

> **Test Tip:**
> If an asset is described as FVTPL, the exam question is usually not asking for an effective interest schedule. Remeasure to fair value and put the gain or loss in profit or loss.

Debt instruments require more thought. A debt asset may be measured at amortised cost if both of the following apply:

- the business model is to hold the asset to collect contractual cash flows; and
- the contractual cash flows are solely payments of principal and interest, often called SPPI.

A debt asset may be measured at FVOCI if it passes the SPPI test and the business model is both to collect contractual cash flows and to sell the asset. Other debt assets are usually measured at FVTPL.

In ACCA FR questions, the wording often signals the category. Phrases such as “held to collect contractual cash flows” usually point to amortised cost, provided the cash flows are principal and interest. Phrases such as “held for trading” or “fair value through profit or loss” point to FVTPL.

For debt instruments at FVOCI, effective interest income is still recognised in profit or loss, but the asset is shown at fair value in the statement of financial position. The fair value movement, after taking account of interest and impairment effects, goes to OCI. This is less commonly tested in basic numerical form than amortised cost or FVTPL, but the principle may appear in written or multiple-choice questions.

### Derecognition and resulting gains or losses

Derecognition means removing a financial asset or financial liability from the statement of financial position.

> **Key Term: Derecognition**
> The removal of a previously recognised financial asset or financial liability from the statement of financial position.

A financial asset is derecognised when the contractual rights to its cash flows expire, or when the asset is transferred and the transfer qualifies for derecognition. In basic ACCA FR terms, if an investment is sold and the entity no longer has the rights and risks attached to it, remove the asset.

The gain or loss on derecognition of a financial asset is usually:

$$
\text{Proceeds received}
-
\text{Carrying amount derecognised} =
\text{Gain or loss}
$$

For an asset measured at amortised cost, that gain or loss is recognised in profit or loss.

For a FVTPL asset, fair value gains and losses have already been recognised in profit or loss up to the date of sale. On disposal, the final gain or loss is based on the difference between the disposal proceeds and the carrying amount at that date.

For an FVOCI debt asset, cumulative gains or losses previously recognised in OCI are reclassified to profit or loss on derecognition. For an FVOCI equity investment, gains and losses are not reclassified to profit or loss on disposal; they may be transferred within equity. ACCA FR questions may test this distinction in a multiple-choice format.

A financial liability is derecognised when the obligation is discharged, cancelled, or expires. For example, if a company repays a loan note, the liability is removed. Any difference between the carrying amount of the liability and the consideration paid is recognised in profit or loss.

For example, if a loan liability has a carrying amount of $980,000 and the company settles it by paying $1,000,000, the loss on settlement is:

$$
1{,}000{,}000 - 980{,}000 = 20{,}000
$$

This loss is reported in profit or loss.

If a lender legally releases a borrower from a debt, the borrower derecognises the liability and recognises a gain if the carrying amount exceeds any amount paid.

> ** Exam Warning:**
> Do not leave a financial liability in the statement of financial position after it has been settled or legally cancelled. Derecognition is based on the obligation ending, not on whether the original maturity date has arrived.

Compound instruments, such as convertible loan notes, can also lead to later effective interest calculations. At issue, the liability component is measured as the present value of future cash flows discounted at the market rate for similar debt without conversion rights. The residual amount is credited to equity. After initial recognition, the liability component is measured using the effective interest method. The equity component is not remeasured.

This matters because the coupon rate on a convertible loan note is often lower than the effective rate used for the liability component. The finance cost is based on the liability carrying amount and the market rate for equivalent non-convertible debt, not simply the cash coupon.

## Key Point Checklist*This article has covered the following key knowledge points:*

- Subsequent measurement means measuring a financial instrument after initial recognition.
- Amortised cost uses the effective interest method.
- Finance income or finance cost is calculated using the effective interest rate on the opening carrying amount.
- Coupon cash received or paid is usually calculated using the nominal amount and coupon rate.
- A debt asset bought at a discount will usually increase in carrying amount over time if measured at amortised cost.
- Issue costs on amortised cost liabilities reduce the initial carrying amount and are spread through finance cost.
- Equity investments are measured at fair value; without an FVOCI election, fair value changes go to profit or loss.
- FVTPL assets are remeasured to fair value, with gains and losses in profit or loss.
- Fair value is not reduced by selling costs.
- A financial asset is derecognised when cash-flow rights expire or a qualifying transfer occurs.
- A financial liability is derecognised when the obligation is discharged, cancelled, or expires.
- Gains or losses on derecognition are usually based on proceeds or consideration compared with the carrying amount removed.

## Key Terms and Concepts

- Subsequent measurement
- Amortised cost
- Effective interest rate
- Transaction costs
- Fair value
- FVTPL
- FVOCI
- Derecognition


Subsequent measurement and derecognition - Effective interest method and fair value changes