HeadStart Financial Reporting (FR)

Professional Accountancy Services Section B | Lecture 11

ACCOUNTING FOR TRANSACTIONS IN FS

IFRS – 9 Financial Instruments
Definition: Financial instruments are contract that gives rise to a “financial asset” of one entity
and a “financial liability or “equity instrument” of another entity. Examples:
• When an invoice is issued on the sale of goods on credit, the entity that has sold the goods has a
“financial asset – the receivable”, while the buyer has a “financial liability – the payable”.
• When an entity raises finance by issuing equity shares, the entity that subscribes to the shares
has a “financial asset – an investment”, while the issuer of the shares who raised finance has to
account for an “equity instrument – equity share capital”.
• When an entity raises finance by issuing bonds, the entity that subscribes to the bonds (i.e. lends
the money) has a “financial asset – an investment”, while the issuer of the bonds (i.e. the
borrower who has raised the finance) has to account for the bonds as a “financial liability”.

Equity instrument Financial liability Compound instrument

Any contract that evidences a When raising finance, the instrument A single instrument might
residual interest in the assets issued will be a debt instrument, as contain both debt and equity
of an entity after deducting all opposed to an equity instrument, where it elements. E.g. a convertible
its liabilities. E.g. issue of contains an obligation to repay. E.g. the bonds
ordinary shares issue of a bond

EQUITY INSTRUMENTS
• Initial measurement – Fair Value (FV) less issue costs
• Subsequent measurement – Not re-measured, because any change in the FV of the shares is not
recognized by the entity, as the gain/loss is experienced by owner of the shares

Practice Question 1: Nab Ltd. issues 10,000 $1 ordinary shares for cash consideration of $2.50 each.
Issue costs are $1,000. Show how it is accounted in the FS of Nab Ltd.

FINANCIAL LIABILITIES

Classification: “Amortized Cost” basis

• Initial measurement – FV less transaction costs (including discounts and issue costs)
• Subsequent measurement – Prepare Amortized cost schedule as shown below
Year Opening Liability Finance cost (SOPL) Cash paid = Closing
Y1 (FV less Trans. Cost)
+ (Op. Liability X Eff. Int.) - BV X Nominal Int. Liability (SOFP)

Practice Question 2: Ajar Ltd. raises finance by issuing zero coupon bonds at par on 1 Jan with a
nominal value of $10,000. The bonds will be redeemed after 2 years at a premium of $1,449. The
effective interest rate is 7%. Prepare SOFP & SOPL extracts for Ajar Ltd.

Practice Question 3: Root Ltd. raises finance by issuing $20,000 6% 4-year loan notes on 1 Jan. The
loan notes are issued at a discount of 10% and will be redeemed at a premium of $1,015. The effective
rate of interest is 12%. The issue costs were $1,000. Prepare the SOFP & SOPL extracts.

www.headstartbd.com
headstart. accountancy 1
01311091323
HeadStart Financial Reporting (FR)
Professional Accountancy Services Section B | Lecture 11
Practice Question 4: On 1 Apr 20X7, a company issued 40,000 $1 redeemable preference shares
with a coupon rate of 8% at par. They are redeemable at a large premium which gives them an
effective finance cost of 12% p.a. How would these shares appear in FS for y/e 31 Mar 20X8 and X9?

COMPOUND FINANCIAL INSTRUMENTS

• Initial measurement – split the debt & equity elements
✓ Cash (Total proceeds from issue) DR
✓ Financial Liability (FV of debt element = PV of future cash flows) CR
✓ Equity – Other components of equity (balancing figure) CR
• Subsequent measurement –
✓ Equity element is not measured subsequently
✓ Debt element is measured as per “Amortized cost” basis

Practice Question 5: Gucci Ltd. issues a 3% $200,000 two-year convertible bond at par. The effective
rate of interest is 8%. The holder of the bond, on the redemption date, has the option to convert the
bond to equity shares at the rate of 10 shares with a nominal value of $1 per $100 debt rather than
being repaid in cash. Transaction costs can be ignored. How is it accounted for in the FS?

FINANCIAL ASSET
Classification and measurement:
Instrument Classification Initial measurement Category Criteria
FV through P/L FV only (TC charged to SOPL) Default -
Debt Amortized cost FV + Transaction cost (TC) Designated If passes 2 tests
FV through OCI FV + TC Designated If passes 2 tests
FV through P/L FV only (TC charged to SOPL) Default Held for trading
Equity
FV through OCI FV + TC Designated Not held for trading

FV through P/L (FVTPL) for “debt” & “equity” instruments:

• This is the default classification for both “equity and debt instruments” and will apply to all
financial assets unless they are designated to be measured and accounted for in any other way.
• Subsequent measurement: Re-measure to FV at each reporting date, with any movement in
FV taken to “SOPL”, which effectively incorporates an impairment review.

Amortized Cost for “debt” instruments only:

• To classify under “Amortised Cost” basis, the following two tests should be passed –
✓ The business model test – here the entity must be holding the financial asset rather than
to sell the instrument prior to its contractual maturity.
✓ The cash flow characteristics test – the contractual cash flows collected must consist
solely of payment of interest and capital.
• Subsequent Measurement:
Year Op. Asset Int. income (SOPL) Cash received Closing
Y1 FV + TC + Op. Asset X Eff. Int. - Nom.value X Nom.Int. = Asset (SOFP)
• If this is not the case, the test is failed, and the financial asset reverts to the default classification
to be measured at “FVTPL”. E.g. a convertible bond.
www.headstartbd.com
headstart. accountancy 2
01311091323
HeadStart Financial Reporting (FR)
Professional Accountancy Services Section B | Lecture 11
FV through OCI (FVTOCI) for “debt” & “equity” instruments:

• It will be applicable for equity investments if an entity “intends to retain ownership of on a

continuing basis”.
• However, investment in debt instrument can be designated at FVTOCI if:
✓ The entity’s business model involves both collecting cash flows and selling financial
assets i.e. sell investments in order to buy better portfolio
✓ The contractual cash flows collected consist solely of interest and capital
• Subsequent measurement: At FV and gain/loss will be recognized in OCI
The accounting treatment automatically incorporates an impairment review, with any change in
FV taken to an investment reserve in equity and shown in OCI. This is like a revaluation of PPE.
The only difference is that there can be a negative reserve.

Practice Question 6: A company invests $5,000 in 10% loan notes. The loan notes are repayable at
a premium after 3 years. The effective rate of interest is 12%. The company intends to collect the
contractual cash flows which consist solely of repayments of interest and capital and have therefore
chosen to record the financial asset at amortized cost. What amounts will be shown in the SOPL and
SOFP for the financial asset for years 1–3?

Practice Question 7: A company invested in 10,000 shares of a listed company in Nov 20X7 at a cost
of $4.20 per share. At 31 Dec 20X7 the shares have a market value of $4.90. Prepare extracts from
the SOPL & OCI for the year ended 31 Dec 2007 and SOFP as at that date.

Practice Question 8: A company invested in 20,000 shares of a listed company in Oct 20X7 at a cost
of $3.80 per share. At 31 Dec 20X7 the shares have a market value of $3.40. The company is not
planning on selling these shares in the short term and elects to hold them as FV through OCI. Prepare
extracts from the SOPL for the year ended 31 Dec 20X7 and a SOFP as at that date.

Practice Question 9: An entity, Suarez, purchased a five-year bond on 1 Jan 2010 at a cost of $5m
with annual interest of 5%, which is also the effective rate, payable on 31 Dec annually. At the
reporting date of 31 Dec 2010 interest has been received as expected and the market rate of interest
is now 6%. Account for the financial asset at 31 Dec 2010 on the basis that it is classified as FVTPL.

www.headstartbd.com
headstart. accountancy 3
01311091323
HeadStart Financial Reporting (FR)
Professional Accountancy Services Section B | Lecture 11
SECTION – A TYPE QUESTIONS
1. On 1 Jan 20X0 Dunston Ltd issued $20m of convertible loan stock, redeemable in 3 years' time
for $22m or convertible into 500,000 ordinary $1 shares. Dunston Ltd’s treasury department has
calculated that the PV of the cash flows, without the conversion option is $19,001,600. What
amounts should be shown in the SOFP for the debt at the date of issue?
A Debt element $19,001,600 and equity element $998,400
B Debt element $998,400 and equity element $19,001,600
C Debt element $20,000,000 and equity element $500,000
D Debt element $22,000,000 and equity element 0

2. An entity acquires a 6% $1,000 bond, for $970, at the beginning of Year 1. Interest is receivable
annually in arrears. The bond is redeemable at the end of Year 3 at a premium of 3% to par value.
The financial asset is measured at amortised cost. The effective interest rate of the financial
instrument can be calculated at 8.1%. Calculate the closing SOFP figure at the end of Year 2.
A $932 B $952 C $988 D $1,009

3. On 1st Jan 20X0, Aditi Plc issued $30m 5% convertible loan stock at par. This is redeemable at
$30m in 3 years or convertible into 1m ordinary $1 shares at the option of the holder. The
effective interest rate without the conversion option is 7%. What amount should be shown as a
liability on the SOFP for the convertible loans stock at the date of issue? (All figures in $000)
A 30,750 B 30,000 C 28,425 D 28,725

4. Sharp Ltd has 5% S1 redeemable preference shares in issue. The preference shares will be
redeemed in 5 years. How should the preference share capital and preference dividend be
presented in the financial statements of Sharp Ltd?
A Preference share capital as equity and preference dividend in SOCIE
B Preference share capital as equity and preference dividend in SOPL
C Preference share capital as a liability and preference dividend in SOCIE
D Preference share capital as a liability and preference dividend in SOPL

5. McTagg purchased 1m shares in Bauer, a listed company, for $4m on 1 Jan. By the year end, the
FV of a Bauer share had moved to $4.80 each. If McTagg were to dispose of the shares, broker
fees of $50,000 would be incurred. What is the correct treatment for shares at year end?
A Hold shares in investments at $4.75million, with $750k gain being taken to the SOPL
B Hold shares in investments at $4.8million, with $800k gain being taken to the SOPL
C Hold shares in investments at $4.8million, with $800k gain shown in the SOCIE
D Hold shares in investments at $4.75million, with $750k gain shown in the SOCIE

6. In order to hold a debt instrument at amortised cost, which TWO of the following tests must be
applied?
A Fair value test
B Contractual cash flow characteristics test
C Investment appraisal test
D Business model test

www.headstartbd.com
headstart. accountancy 4
01311091323
HeadStart Financial Reporting (FR)
Professional Accountancy Services Section B | Lecture 11
7. Grafton Co’s draft statement of financial position as at 31 March 20X8 shows financial assets at
fair value through profit or loss with a carrying amount of $9.5 million as at 1 April 20X7. These
financial assets are held in a fund whose value changes directly in proportion to a specified
market index. At 1 April 20X7, the relevant index was 1,100 and at 31 March 20X8, it was 1,187.
What amount of gain or loss should be recognised at 31 March 20X8 in respect of these assets?
 $827,000 gain  $751,000 gain  $1,000,000 loss  $827,000 loss

8. Zebidee Co purchases a deep discount bond with a par value of $500,000 on 1 January 20X1 for
proceeds of $440,000 with the intention of holding it until the redemption value is received.
Annual coupon payments of 5% are payable on 31 December. Zebidee Co incurred transaction
costs of $5,867. The bond will be redeemed on 31 December 20X3 at par. The effective interest
rate on the bond has been calculated at 9.3%.
What is the interest income in the profit or loss for the year ended 31 December 20X2?
 $40,914  $41,466  $42,997  $44,670

www.headstartbd.com
headstart. accountancy 5
01311091323