Financial statement disclosures.Financial Statement Disclosures The exposure draft on financial instruments concerns requires disclosures of these instruments and related transactions. Disclosure is made of both recognized and unrecognized instruments. The information is useful to stockholders, potential investors, creditors, suppliers, customers and management in their decision-making processes Presented below is a list of topics on decision-making and decision-making processes: | width="" align="left" valign="top" |
| width="" align="left" valign="top" | A financial instrument is a contract whether recognized or unrecognized that is both a financial asset of one firm and a financial liability or equity instrument of another. It includes cash, receivables, payables, debt, equity securities, options, financial futures financial futures Obligations to buy or sell particular positions in financial instruments. The features of financial futures are identical to those of any futures contract except that the asset for delivery is of a financial nature. , forward contracts, financial guarantees, interest rate and currency swaps Currency Swap A swap that involves the exchange of principal and interest in one currency for the same in another currency. Notes: Currency swaps were originally done to get around the problem of exchange controls. , collateralized mortgage obligations Collateralized mortgage obligation (CMO) A security backed by a pool of pass-through rates , structured so that there are several classes of bondholders with varying maturities, called tranches. , etc. For example, equity securities include common stock, preferred stock Stock shares that have preferential rights to dividends or to amounts distributable on liquidation, or to both, ahead of common shareholders. Preferred stock is given preference over common stock. Holders of preferred stock receive dividends at a fixed annual rate. , stock options, stock warrants, certificate of interest or participation and partnership agreement. Disclosure regarding financial instruments is essential for investment and credit decision-making since it provides information regarding credit risks, interest rates, market prices, future cash receipts and cash payments and contingent obligations. Credit Risks Credit risk refers to the failure of a party to honor contractual terms A contractual term is "[a]ny provision forming part of a contract"[1] Each term gives rise to a contractual obligation, breach of which will can give rise to litigation. . Disclosures are to be made either in the body of the financial statements or in the footnotes concerning each type of financial instrument having credit risk. The following credit risks may exist: maximum, reasonably possible and probable. Maximum Credit Risk Maximum credit risk is when there is a complete dishonor To refuse to accept or pay a draft or to pay a promissory note when duly presented. An instrument is dishonored when a necessary or optional presentment is made and due acceptance or payment is refused, or cannot be obtained within the prescribed time, or in case of bank collections, of the obligation and any collateral placed is worthless. The maximum credit risk is to be given for recognized financial assets Financial assets Claims on real assets. which is typically the carrying value Carrying Value Also know as "book value," it is a company's total assets minus intangible assets and liabilities, such as debt. Notes: This is different than market value, as it can be higher or lower depending on the circumstances. . If carrying value is used, no disclosure is needed. Recognized financial liabilities and unrecognized financial instruments should be identified and the maximum credit risk exposure shown by type. When an offset right exists, the maximum credit risk is the net asset after deducting the liability set-off. For instance, an asset of $200,000 and a related liability of $60,000 would be shown net at $140,000. A measure of maximum credit risk for a financial guarantee is the discounted value of future payments that may not be made. The measure of maximum credit risk for a loan commitment is the amount of the loan under the commitment terms (e.g. letter of credit). The valuation of the maximum credit risk associated with an unrecognized interest rate swap Interest Rate Swap A deal between banks or companies where borrowers switch floating-rate loans for fixed rate loans in another country. These can be either the same or different currencies. or forward currency contract is the current market rates to replace the swap or forward contract if there is a default by the counter party. This amount constitutes the market value of the instrument. Disclosure is made when the maximum credit risk of all financial instruments with a particular party is either (1) in excess of 20% or (2) exceeds 10% of total assets. Information disclosed includes data regarding the counterparty Counterparty The other participant, including intermediaries, in a swap or contract. (e.g. industry, geographic location) and the particulars regarding the degree and amount of credit risk (e.g. reasonably possible credit loss). Reasonably Possible Credit Loss The reasonably possible credit loss is the one incurred by the firm because a counterparty dishonored dis·hon·or n. 1. Loss of honor, respect, or reputation. 2. The condition of having lost honor or good repute. 3. A cause of loss of honor: was a dishonor to the club. 4. his contractual payments. Disclosure should be made of the remaining credit loss that is at least reasonably possible including the upper and lower range of loss. If an estimate is not ascertainable, the maximum credit risk associated with the financial instrument should be specified along with descriptive data about it (e.g. collateral, counterparty). Loans made to risky foreign countries should be disclosed including the amount, identification of foreign areas and the terms. Probable Credit Loss The probable credit loss is the loss likely to be incurred because of a counterparty's failure to carry out a contractual agreement. Accrual accrual, n continually recurring short-term liabilities. Examples are accrued wages, taxes, and interest. is made of the probable credit loss. In addition, the probable loss should be stated in the footnotes for each class of financial instruments. Credit Risk Disclosures Disclosure is required of credit risk for significant group concentrations of counterparties Counterparties The parties on either side of an interest rate swap or a currency, equity or commodity swap, or to an options or futures position. . A group concentration is when counterparties are involved in similar activities so they are susceptible to common conditions (e.g. economic factors). Information footnoted includes data about the shared geographic location and the amount of credit risk. Industry or regional concentrations of credit risk have to be disclosed including a description of the nature of the businesses involved. For instance, a retail concern may provide information regarding the type of business, geographic location, credit policy and experiences with customers. Recommended disclosures also exist for collateral and security supporting financial instruments having credit risk. Disclosure is suggested when the source of repaying a loan is restricted by a nonrecourse arrangement for funds derived from the sale or use of collateral. A typical disclosure might be: On December 31, 19X2, X Company had security interests in machinery as collateral in support for its leases receivable. Market Value A financial asset is defined as cash, right to receive cash or other financial asset, right to exchange other financial instruments on favorable terms or another firm's equity instrument. A financial liability is an obligation to pay cash or give an asset to another firm or to exchange financial instruments on potentially unfavorable terms with another business. An equity instrument is an ownership interest in another entity. Financial assets and liabilities should be reported at market values by class in the body or footnotes to the financial statements. If the market value is not ascertainable, footnote disclosure should be made of that fact. Market value is based on quoted prices. When quoted market prices are not available, there should be an estimate made of the market value. The estimate may be tied into the market price of a similar financial asset or liability (e.g. similar terms, risk) or another measure indicative of current prices. For example, in the event a quoted market price does not exist for a loan, the market value is estimated based on the market prices of similar loans or financial assets with similar credit ratings, interest rates and maturities. When estimates are required, disclosure should be made of the method and assumptions used. In the case where market value of a financial instrument is not determinable Liable to come to an end upon the happening of a certain contingency. Susceptible of being determined, found out, definitely decided upon, or settled. determinable adj. or estimable es·ti·ma·ble adj. 1. Possible to estimate: estimable assets; an estimable distance. 2. Deserving of esteem; admirable: an estimable young professor. , disclosure should be made of the reasons why market value may not be expressed and of interest rate, carrying amount, maturity and other characteristics relevant to the valuation of the financial instrument. Prices for financial instruments may be quoted in several markets. Typically, the price in the most active market will be the most appropriate market value to use. It is suggested that the company disclose that if it sold all of the financial instruments held, the amount received may be less than the recorded or disclosed amount because a significant sales volume would downwardly affect market price. In the event that possible taxes and other expenses related to the sale or settlement of a financial instrument have not been taken into account, a disclosure of that fact should be made. Future Cash Receipts and Cash Payments A company must disclose in the body or footnotes to the financial statements data about future contractual cash receipts and cash payments resulting from financial instruments. Disclosure should be made of the dates they are contractually to take place. The disclosure includes principal, interest, preferred dividends preferred dividend n. a payment of a corporation's profits to holders of preferred shares of stock. (See: preferred stock) and other contractual information. However, this requirement does not apply to financial instruments to be settled prior to maturity for which market value is presented in the financial statements. Information must be given as to the future dates and amounts of financial instruments according to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. the contract, or, if not fully stated in the agreement, disclosure should be given to that effect. If the future dates and amounts are contingent upon Adj. 1. contingent upon - determined by conditions or circumstances that follow; "arms sales contingent on the approval of congress" contingent on, dependant on, dependant upon, dependent on, dependent upon, depending on, contingent future occurrences, that fact should be specified. The timing of cash flows of financial instruments that may be impacted by certain events include demand deposits of banks and mortgages containing pre-payment options. In these cases, the contracted dates are the earliest ones for which the creditor can demand payment (for example, the next business day for the bank). Disclosure should be made of the maturity date, carrying value and effective interest rate for each major category of financial instruments. The disclosed amounts for a financial asset or financial liability involving a right of exchange of financial instruments are the amounts to be exchanged as per the terms of the contract. Disclosure is made of cash receipts and cash payments that are to take place within one year, between one year and five years and after five years. It is suggested that subdivision of those intervals occur, particularly for intervals that include more than half of a company's future cash receipts and cash payments. Information may be included in narrative or tabular form Same as table view with respect to printed output. . Certain financial instruments do not have a mandatory redemption date Redemption date The date on which a bond matures or is redeemed. redemption date The date on which a debt security is scheduled to be redeemed by the issuer. The redemption date is the scheduled maturity date or, if applicable, a call date. so there is no required future cash payment for principal. An example is the par value of preferred stock. In this case, disclosure is needed, but the future periodic cash payments (e.g. dividends) should be specified. There should be disclosure of foreign currency items whose future cash flows or have material effects on the firm's overall interest rates. Here, aggregate amounts can be presented for total financial assets, total financial liabilities and total equity. Prepayment Prepayment 1. The payment of a debt obligation prior to its due date. 2. The excess payment over a scheduled debt repayment amount. Notes: 1. Examples include deferred expenses such as rent and early loan repayments. 2. provisions for financial instruments should be disclosed. Where anticipated cash receipts and cash payments may differ materially in amount or timing from the contractual provisions due to option clauses, it is recommended that such information be disclosed. Interest Rates Disclosure of the effective interest rates, carrying values, maturity dates and contractual repricing Repricing To change the price of an asset. In derivatives, it sometimes refers to the exchange of options of with different strike prices. repricing associated with interest-bearing financial instruments should be made. However, this information need not be presented for instruments held for sale being reported at market value. Data regarding interest rates may be disclosed for individual financial instruments or weighted averages for the total financial instruments by class. Disclosure of interest rates may be made in narrative form (e.g. recommended for a small business) or tabular form (e.g. a larger business). When the anticipated repricing or maturity dates of financial instruments differs materially from contractual requirements due to possible contingencies and options, appropriate disclosure is required. It is assumed that a financial instrument reported as current is noninterest bearing. If not, such must be stated in the footnotes. Information should be presented regarding interest rates of financial instruments denominated in foreign currencies when there is a material impact on the company's overall average effective interest rates. It is recommended that there be a subdivision of the intervals, particularly for intervals that comprise in excess of 50% of the firm's total financial assets and liabilities. Contingent Obligations A contingent obligation may exist when a borrower pays a fee to the guarantor guarantor n. a person or entity that agrees to be responsible for another's debt or performance under a contract, if the other fails to pay or perform. (See: guarantee) GUARANTOR, contracts. He who makes a guaranty. 2. of a loan and the guarantor commits to reimburse re·im·burse tr.v. re·im·bursed, re·im·burs·ing, re·im·burs·es 1. To repay (money spent); refund. 2. To pay back or compensate (another party) for money spent or losses incurred. the lender in the event of borrower default. The guarantor recognizes a financial liability while the lender records a financial asset. Pension Plans Pension plan liabilities are financial obligations to pay cash to retired employees as per a contractual arrangement. Pension plan assets consist of cash, receivables, equity securities, bonds, financial instruments and nonfinancial assets Nonfinancial assets Physical assets such as real estate and machinery. (e.g. real estate). Hence, pension liabilities Pension liabilities Future liabilities resulting from pension commitments made by a corporation. Accounting for pension liabilities varies widely by country. and almost all pension plan assets are financial instruments. Conclusion To provide meaningful information to financial readers about financial instruments, disclosure is needed of credit risks including maximum credit risk, reasonably possible credit loss and probable credit loss. Data on interest rates also provide clues as to a company's financing strategy. The market value of securities is also relevant as well as expected cash receipts and cash payments. Contingent obligations must be presented for appraising possible future obligations. Joel G. Siegel, Phd, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , is an accounting consultant and professor of accounting at Queens College Queens College: see New York, City Univ. of. of the City University of New York The City University of New York (CUNY; acronym: IPA pronunciation: [kjuni]), is the public university system of New York City. . Peter Chiu, JD, is a financial consultant and professor of accounting at Queens College of the City University of New York |
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