- 15 Marks
FR – L2 – Q57 – Financial Instruments
Question
UNION COOPERATIVE LTD
On 1 July 20X4, Union Cooperative Ltd., issued 20,000 8% debentures at GH¢97.50. The security is redeemable in five years’ time. The interest on the debentures is payable bi-annually on 30 June and 31 December.
On 31 December 20X4, the company’s year-end date, the debentures were quoted on the Ghanaian Stock Exchange for GH¢96.00. The company accountant has suggested each of the following as possible valuation basis for reporting the debentures liability on the statement of financial position as at 31 December 20X4: (i) Face value of the debentures. (ii) Face value of the debenture plus interest payment for five years. (iii) Market value on the statement of financial position as at the year end.
Required
(a) Determine the face value of the debentures and the proceeds accruing to the company.
(b) Determine the amount and explain the nature of the differences between the face value and the market value of the debentures on 1 July, 20X4.
(c) Distinguish between nominal and effective rate of interest.
(d) Determine the nominal interest payable on the debentures for the year ended 31 December 20X4.
(e) State arguments for or against each of the suggested alternatives for reporting the debentures liability on the statement of financial position as at 31 December 20X4.
Answer
51 UNION COOPERATIVE LTD
(a) The face value of the debentures
GH¢100 × 20,000 = GH¢2,000,000
The amount accrued to the company as proceeds =
GH¢97.5 × 20,000 = GH¢1,950,000
(b) The difference between the face value and the market value of the debentures is GH¢50,000. This is as a result of discount allowed on the issue on the debentures. Discount on debentures attracts investors.
(c) Nominal interest rate is the rate based specifically on the face value of the loan capital. In case of Union Cooperative Ltd., the nominal interest rate on the debentures is 8% per annum on GH¢2,000,000.
The effective interest is the rate based on the market value. This is the actual value collected on issue which can be at par, discount or premium. For Union Cooperative Ltd., the effective interest rate will be 8% of GH¢1,950,000
(d) The nominal interest payable
GH¢2,000,000 × 8% × 6 months ÷ 12 months = GH¢80,000
(e) (i) The face value of GH¢2,000,000 will be the most appropriate valuation to be disclosed in the statement of financial position. The management may be interested in the quoted market value or the proceeds, but for the sake of outside investors who would only be interested in the company having good reputations devoid of trading losses, it is advisable that the face value be adopted.
(ii) Disclosing the debentures’ liability at face value plus interest payment for five years may seem proper in the eyes of external investors and credit institutions, but principally, it would be wrong to credit debentures’ account with both the face value and the interest payments. An interest payment on debentures is a revenue item which is debited to the statement of profit or loss.
(iii) Disclosing debentures’ liability at market value on the Statement of financial position will amount to disclosure at replacement value. The market value should be disclosed.
This is the complete and exact reproduction of the answers for Question 57, including all subparts, as they appear in the attachment. No changes have been made to the text, and all details, including calculations and explanations, are included as presented in the original document.
- Tags: Debentures, Face Value, Financial Position, Market value, Valuation
- Level: Level 2
- Uploader: Samuel Duah