- 4 Marks
Question
DanKay Ltd bought a ten-year bond on 1 August 2016 at a cost of GH¢45 million. The bond carries an interest coupon of GH¢5 million paid annually in arrears, and its effective yield to maturity was 12% at the date of purchase. DanKay Ltd is holding the bond as a speculative investment, expecting its value to increase, and hopes to sell the bond at a profit in the short to medium term. On 31 July 2017, its reporting date, the fair value of the bond had declined to GH¢43 million. The interest payment was received as scheduled.
Required:
Advise DanKay Ltd on the treatment of the above in the financial statements for the year ended 31 July 2017 in accordance with IFRS 9: Financial Instruments.
Answer
- Business Model Test:
Since DanKay Ltd is holding the bond as a speculative investment and does not intend to hold it to maturity, the bond fails the “Business Model” test under IFRS 9. This means it cannot be measured using the amortized cost method. - Fair Value Measurement:
Because DanKay Ltd intends to sell the bond in the short to medium term, the bond must be measured at fair value through profit or loss (FVPL). As of 31 July 2017, the fair value of the bond has declined to GH¢43 million, indicating a fair value loss of GH¢2 million (GH¢45 million initial cost – GH¢43 million fair value). - Interest Income:
The GH¢5 million interest coupon received during the year should be recognized as interest income in the statement of profit or loss. - Net Impact on Profit or Loss:
The fair value loss of GH¢2 million should be recognized in profit or loss for the year ended 31 July 2017, resulting in a net gain of GH¢3 million (GH¢5 million interest income – GH¢2 million fair value loss).
(4 marks)
- Tags: Amortized Cost, Bond Valuation, Fair Value, Financial instruments, Investment
- Level: Level 3
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