(a) The measurement of financial instruments is dependent on the business model of the entity. The business model of an entity can typically be observed through the activities which an entity undertakes to achieve its business objective. The business model is a matter of fact rather than an assertion.
The assessment of a business model is based on how key personnel actually manage the business, rather than management’s intent for specific financial assets. It implies a more rigorous test and may potentially require entities to provide additional evidence or accumulate more historical analysis. IFRS 9 Financial Instruments has taken a strategic approach as the business model test requires companies to assess the nature of their business and how it allocates its financial assets. It is not as simple as establishing the nature and risk of the asset itself.
Financial assets are held at amortised cost where the entity has a business model whose objective is to hold assets to collect contractual cash flows. Having some sales activity is not necessarily inconsistent with this business model. For example, sales which are infrequent or insignificant in value or have been made as a result of an increase in credit risk may be consistent with this business model.
Financial assets classified and measured at fair value through other comprehensive income are held in a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets. Compared to a business model whose objective is to hold financial assets to collect contractual cash flows, this business model will typically involve greater frequency and volume of sales. This measurement category results in amortised cost information being provided in profit or loss and fair value information in the statement of financial position.
It appears that Spamgate has a business model whose objective is to hold assets in order to collect contractual cash flows as it seldom buys and sells financial assets but issues loans to individuals and businesses. It has only accepted the preference shares in Bosey because of the poor liquidity position of Bosey. Although Spamgate intends to sell the preference shares held in Bosey as soon as it is feasible, it does not intend to change its business model. Therefore, both the loans and the shares in Bosey should be valued at amortised cost.
The exchange of part of the loan for Bosey’s shares should lead to the derecognition of that part of the loan as Spamgate’s rights to that part of the loan have expired and the risks and rewards relating to that part of the loan have been extinguished.
Upon derecognition, the difference between the carrying amount of the loans and the fair value of the preference shares received should have been presented as a loss on loans instead of reducing the carrying amount of the loans, with an offsetting increase in the value of the investment in Bosey’s shares. In addition, the valuation of the preference shares was not based upon their fair value as the share price used to calculate the exchange rate for the loans was three times higher than the subscription price for the unsuccessful share issue. This seems to indicate that the fair value of the shares received in the conversion was considerably lower than that used to reduce the carrying amount of the converted loans.
In addition, Spamgate is required, under IFRS 9, to recognise expected credit losses and to update the amount of expected credit losses recognised at each reporting date to reflect changes in the credit risk of financial instruments. This does not appear to have occurred.
For financial assets carried at amortised cost, a gain or loss is recognised when the financial asset is derecognised. Upon derecognition, the difference between the loans’ carrying amount and the fair value of the shares received should have been recognised as a gain or loss.
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