Financial Liabilities

3.2 Financial Liabilities

3.2.1 There are two principal categories of financial liabilities: (1) Financial liabilities at fair value through profit or loss (FVTPL)

(2) Financial liabilities measured at amortized cost

3.2.2 Additionally, IAS 39 provides accounting requirements for issued financial guarantee con- tracts and commitments to provide a loan at a below-market interest rate.

3.2.3 Financial liabilities at fair value through profit or loss include financial liabilities that the entity either has incurred for trading purposes or otherwise has elected to classify into this cate- gory. Derivative liabilities are always treated as held for trading unless they are designated and ef-

fective hedging instruments. The designation of hedging instruments is discussed later in this chapter.

3.2.4 An example of a liability held for trading is an issued debt instrument that the entity intends to repurchase in the near term to make a gain from short-term movements in interest rates. Another example of a liability held for trading is the obligation that arises when an entity sells a security that it has borrowed and does not own (a so-called short sale).

3.2.5 As with financial assets, the ability to selectively classify financial instruments as items measured at fair value with changes in fair value recognized in profit or loss is referred to as the fair value option. This fair value option may be applied only at initial recognition and only if any of these conditions are met:

• Such designation eliminates or significantly reduces a measurement or recognition inconsis- tency (sometimes referred to as an accounting mismatch) that would otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases.

• A group of financial assets, financial liabilities, or both are managed and evaluated on a fair value basis in accordance with a documented risk management or investment strategy, and information is provided internally on that basis.

• An instrument contains an embedded derivative (unless that embedded derivative does not significantly modify the instrument’s cash flows under the contract or it is clear with little or no analysis that separation of the embedded derivative is prohibited).

3.2.6 The second category of financial liabilities is financial liabilities measured at amortized cost. It is the default category for financial liabilities that do not meet the definition of financial

liabilities at fair value through profit or loss. For most entities, most financial liabilities will fall into this category. Examples of financial liabilities that generally would be classified in this cate- gory are account payables, note payables, issued debt instruments, and deposits from customers.

3.2.7 In addition to the two categories of financial liabilities just listed, IAS 39 also addresses the measurement of certain issued financial guarantee contracts and loan commitments. A financial

guarantee contract is a contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accor- dance with the original or modified terms of a debt instrument. After initial recognition, IAS 39 requires issued financial guarantee contracts to be measured at the higher of (a) the amount deter- mined in accordance with IAS 37, Provisions, Contingent Liabilities and Contingent Assets, and (b) the amount initially recognized less, when appropriate, cumulative amortization. A similar re- quirement applies to issued commitments to provide a loan at a below-market interest rate.