- 15 Marks
Question
Aribatise is a public liability company which holds a few financial instruments:
Required: Discuss how these transactions should be accounted for in accordance with IAS 32 and IFRS 9 in the financial statements to December 31, 2024.
a. A 3% bond purchased on January 1, 2022 for N500,000. The nominal value is N600,000 and redemption will be at par on December 31, 2027. The coupon is received annually in arrears. The effective interest rate on the bond is 9.7%. The company has classified the bond as “held to maturity”. The market value of the bond at December 31, 2024 is N550,000.
(4 Marks)
b. An investment was made in the equity shares of Ojutiri Plc. 6,000 shares were purchased (a 1% stake) at a cost of N20 per share on April 1, 2022. A transaction fee of N600 was charged on the purchase. The firm intended to sell the shares within three months and so classed the investment as fair value through profit or loss. The market value of the investment continued to rise and so the company decided not to sell in the near future. The market value of the shares over the three years has been as follows:
| N’000 | |
|---|---|
| December 31, 2022 | 64 |
| December 31, 2023 | 68 |
| December 31, 2024 | 70 |
(5 Marks)
c. The company issued a convertible bond at par on December 31, 2024, raising N1,000,000. The coupon on the bond is 4%. The rate on an equivalent redeemable bond is 7%. The bond can be redeemed at par on December 31, 2027 or converted into equity shares at a rate of five shares per N200. The bond has not been classed as fair value through profit or loss. (6 Marks)
Answer
(a) Accounting for 3% bond in accordance with IAS 32 and IFRS 9
i. The bond must initially be recorded at its purchase price of ₦500,000;
ii. If classified as „held to maturity‟, it must be re-measured at the end of the reporting period to its amortised cost;
iii. The market value is not relevant;
iv. Interest will be credited to profit or loss using the effective interest rate, resulting in finance income of ₦48,500 (9.7% x ₦500,000);
v. The effective rate reflects the total return received by the investor over the duration of the bond minus the coupon plus ₦100, 000 premiums on redemption;
vi. The coupon recorded in the statement of cash flows is ₦18,000 (3% x ₦600,000); and vii. The difference between the effective interest and the actual coupon is added to the investment to give an amortised cost at the end of Year 3 of ₦530, 500 (₦500,000 + ₦48,500 – ₦18,000).
(b) Accounting for equity shares in Ojutiri Plc. in accordance with IAS 32 and IFRS 9
i. The shares will initially be recorded at their cost of ₦60,000;
ii. As they have been classified as fair value through profit or loss the transaction costs must be expensed to profit or loss immediately;
iii. At the end of each reporting period, the shares must be re-measured to their market value, with the resulting gain or loss being taken to profit or loss;
iv. At January 1, year 3 the investment has a carrying value of ₦68,000. By the December 31, year 3, this value is now ₦71,000. A ₦3,000 gain will therefore be recognised in profit or loss for the year; and
v. Even though the investment is no longer intended for sale in the short term, it must remain classified as fair value through profit or loss as IAS 32 does not permit reclassification into or out of this category.
(c) Accounting for a convertible bond in accordance with IAS 32 and IFRS 9
i. A convertible bond represents a compound instrument. In essence, issuing a convertible bond is equivalent to issuing a non-convertible bond plus a call option on the entity‟s shares;
ii. Therefore, the investment should be divided into a liability portion and an equity portion;
iii. To establish the liability (debt) element, the future cash flows from the bond are discounted at the normal market rate to establish the value of an equivalent but redeemable bond;
iv. Using a rate of 7% gives a net present value of:
(₦40,000 /1.07) + (₦40,000/ 1.07 x 1.07) + (₦1,040,000 1.07 x 1.07 x 1.07) = ₦921, 270;
v. As the bond was issued for ₦1, 000,000, it implies that the call option embedded within the bond was sold for ₦78,730 (₦1,000,000 – ₦921,270); and vi. Therefore, the proceeds of ₦1,000,000 will be shown in the statement of cash flows as a financing cash flow, and the credit will be split into non- current liabilities ₦921,700 and equity ₦78,730.
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