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Week 7 Solution To Self-Review Questions

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29 views2 pages

Week 7 Solution To Self-Review Questions

Uploaded by

jiejialing08
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110.

309 Week 7 Solution to Self-review Questions

14.11 Compound financial instruments include both equity instruments and financial liabilities. The
debt and equity components of a compound security should be accounted for and disclosed
separately on the basis of the economic substance of the security at the time of its initial
recognition. As paragraph AG31 of NZ IAS 32 states:

A common form of compound financial instrument is a debt instrument with an embedded


conversion option, such as a bond convertible into ordinary shares of the issuer, and
without any other embedded derivative features. Paragraph 28 requires the issuer of such
a financial instrument to present the liability.

We must determine the fair value of the liability component—which is recognised within the
financial statements—and allocate the difference between the fair value of the liability
component and the fair value of the entire instrument to the equity component. That is, the
amount attributed to the equity component is the residual.

14.17 If a financial instrument is designated as debt then the related payment would be considered to
be interest expense, and this would reduce profits. By contrast, if the financial instrument is
considered to be equity, then the related payment would be of the form of dividends, and this
is an appropriation of profits, or retained earnings, and is not considered an expense. Therefore,
profit or loss would not be impacted by a dividend payment

14.36 To calculate the issue price of the bonds we need to determine the present value of the future
cash flows. We will use the market’s required rate of return as the interest rate necessary to
determine the present value.
Present value of annual payments: $100 000 × 3.4331 $343 310
Present value of principal repayment: $1 000 000 × 0.5194 $519 400
$862 710

Determining amortised cost using the effective-interest method


1. Year ended 2. Opening 3. Payment 4. Interest at 5. Increase in 6. Amortised
bond 14% (column bond payable cost of bond
payable 2  14%) (column 4 – payable
column 3) (column 2 +
column 5)
$ $ $ $ $
30 June 2023 862 710 100 000 120 779 20 779 883 489
30 June 2024 883 489 100 000 123 689 23 689 907 178
30 June 2025 907 178 100 000 127 005 27 005 934 183
30 June 2026 934 183 100 000 130 786 30 786 964 969
39 June 2027 964 969 100 000 135 096 35 095 1 000 064
1 000 000 64*
*rounding error of $64 due to using present values to only 4 decimal places.

The annual interest cost is measured by multiplying the effective interest rate by the amount of liability
at the beginning of each period. Any excess of interest cost over the amount of interest paid is accounted
for as an increase in the carrying amount of the liability (which is its present value). By the maturity
date, the liability will be increased to an amount equal to the principal, as the discount reduces to zero.

1
Journal entries

1 July 2022
Dr Cash 862 710
Cr Bond payable 862 710
(Issuing bonds for $862 710)

30 June 2023
Dr Interest expense 120 779
Cr Bond payable 20 779
Cr Bank 100 000
(Interest payment and amortisation of
bond payable using effective-interest
rate of 14%)

14.41 (a) The convertible bonds will be shown as part debt and part equity. The amount attributed
to the liability will be the present value of the contractually required cash flows
discounted at the market’s required rate of return. The difference between this liability
component and the issue price of the securities would represent the equity component.

(b) No, the probability of conversion to equity does not influence whether they are disclosed
as debt or equity. This is specifically stated in the accounting standard NZ IAS 32.

(c) Yes it will. The balance existing in the liability account (Convertible bonds liability), and
the balance in the existing equity account (Convertible bonds) would be transferred to
Share capital. The entry would be:
Dr Convertible bonds liability x
Dr Convertible bonds x
Cr Share capital x

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