- 5 Marks
Question
On 1 June 2017, Bole Bamboi Ltd (Bole Bamboi) purchased a factory building in a regional development area for GH¢4 million. It used the building to store some relocated equipment, but shortly after the purchase, the roof needed to be replaced. Bole Bamboi has been replacing the roof of the factory building with an environmentally friendly one, including insulation and integrated solar panels. The replacement of the roof will cost GH¢2 million. The cost of the replacement is to be incurred by Bole Bamboi; however, the Ministry of Trade and Industry advanced a 5-year, interest-free loan to Bole Bamboi on 1 July 2017 to finance the GH¢2 million cost. The loan has to be repaid in 5 equal annual instalments of GH¢400,000 beginning on 30 June 2018. An equivalent loan from Bole Bamboi’s bank with the same repayment terms would have been made at a fixed annual interest rate of 5% for the 5 years.
The present value of 5 annual payments of GH¢1 at 5% is GH¢4.32948.
Required:
In accordance with IFRS, recommend, with suitable calculations, the financial reporting treatment of the above items in the financial statements of Bole Bamboi for the year ended 31 December 2017.
Answer
- Initial Recognition of the Loan:
- The interest-free loan should be initially recognized at its fair value, which is calculated by discounting the future repayments at the market rate of interest (5%).
- The present value of the loan is calculated as follows:
- Present value of loan = GH¢400,000 × 4.32948 = GH¢1,731,791.
- The difference between the face value of the loan (GH¢2 million) and the present value of the loan (GH¢1,731,791) is recognized as deferred income, which represents a government grant.
Journal Entries:
- Debit Cash: GH¢2,000,000
- Credit Loan (Liability): GH¢1,731,791
- Credit Deferred Income (Government Grant): GH¢268,209
- Subsequent Measurement (Interest and Grant Amortization):
- The loan liability should be unwound using the effective interest rate method. Interest expense is recognized on the loan liability at 5% per annum.
- For the year ended 31 December 2017:
- Interest expense = GH¢1,731,791 × 5% = GH¢86,590.
- The government grant should be amortized to profit or loss to match the interest expense, ensuring the interest cost is offset by the grant. The amount of grant recognized as income in 2017 would be GH¢86,590, so that the net effect on profit or loss is neutral.
Journal Entries for 2017:
- Debit Interest Expense: GH¢86,590
- Credit Loan (Liability): GH¢86,590
- Debit Deferred Income (Government Grant): GH¢86,590
- Credit Other Income: GH¢86,590
- Amortization of the Government Grant:
- The remaining deferred income will be amortized over the 5-year loan repayment period, offsetting the interest expense in each year.
- Tags: Discounting, Fair Value, Financial Reporting, Government Loan, Interest-Free Loan
- Level: Level 3
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