UKAF4034 Advanced Corporate Reporting

TUTORIAL 13
Financial Instruments
(Answer)

Question 1
Part (1)
Proceeds from note issue 2,000 x RM1,000 = RM2,000,000
Need to apply the ‘split accounting’ method.

This requires the determination of the ‘liability component’ of the instrument,

being:

Liability component:
Yea
Interest Principal Sum DF @ 9% PV
r
1 120,000 120,000 0.9174 110,092
2 120,000 120,000 0.8417 101,002
2,000,00 2,120,00
3 120,000 0.7722 1,637,029
0 0
1,848,122

Hence, the equity component = RM2,000,000 – 1,848,122 = RM151,878

Part (2)
Amortization schedule:

Year Opening Interest Interest Closing

  Balance @ 9% paid @ 6% Balance
2013 1,848,122 166,331 120,000 1,894,453
2014 1,894,453 170,501 120,000 1,944,954
2015 1,944,954 175,046 120,000 2,000,000

Amount to be repaid to bondholders

Part (3)
Journal entries:

1.1.2013
Dr Bank RM2,000,000
Cr 6% convertible notes RM1,848,122
Cr Equity component RM 151,878

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UKAF4034 Advanced Corporate Reporting

31.12.2013
Dr Interest expense RM166,331
Cr 6% convertible notes RM 46,331
Cr Cash and bank RM120,000

2014:
31.12.2014
Dr Interest expense RM170,501
Cr 6% convertible notes RM 50,501
Cr Cash and bank RM120,000

2015:
31.12.2015
Dr Interest expense RM175,046
Cr 6% convertible notes RM 55,046
Cr Cash and bank RM120,000

Assuming that all the holders of the note chose to accept equity shares on 31
December 2015
Journal entry:
Dr 6% convertible notes RM2,000,000
Equity RM 151,878
Cr Ordinary share RM 500,000
Share premium RM1,651,878

Part (4)
Extracts of the Statement of Comprehensive Income for the year ended 31
December
2013 2014 2015
RM RM RM
Interest expense 166,331 170,501 175,046

Extracts of the Statement of Financial Position as at 31 December

2013 2014 2015
RM RM RM
Equity component 151,878 151,878 151,878
Liabilit
y
5% convertible bonds 1,894,453 1,944,954 2,000,000

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Question 2

Amortised cost
Using amortised cost, both the initial loan and the new loan result in single payments that
are almost identical on 30 November 2021:
Initial loan: $47m x 1.05 for 5 years $59.98m
New loan: $45m x 1.074 for 4 years $59.89m

However, the carrying amounts at 30 November 2017 will be different:

Initial loan: $47m + ($47m x 5%) = $49.35m
New loan: $45m

Fair value
If the two loans were carried at fair value, both the initial loan and the new loan would
have the same value, and be carried at $45m. There would be a net profit or $2m, made
$49.35m $45m of the interest expense of $47m x 5% = $2.35m and the unrealised gain or
$4.35m.

Arguably, since the obligation on 30 November 2021 will be the same for both loans, fair
value is a more appropriate measure than amortised cost

Question 3
Investment in the Public Bank shares

The investment is revalued to fair value at the reporting date. A loss on RM200,000 results. This
is recognised in the other comprehensive income, this election is irrevocable, as Tony Bhd made
an election to do so at date of purchase.

At 31 December 2018
Dr: Other comprehensive income RM200,000
Cr: Financial assets RM200,000

Investment in a bond issued by Open Bhd

Tony Bhd to retain the bond in order to collect the contracted cashflow on the due dates and
the business model is to hold this bond until maturity, thus, “amortised cost” method should
applied.

The interest earned during the year ended 31 December 2018 was RM1,600,000 ( 8% x RM20
million). As this is not payable until the anniversary of the bond’s issue 1 January 2019, an
accrual must be made for this amount.

At 31 December 2018
Dr: Interest receivable (current assets) RM1,600,000
Cr: Profit or loss RM1,600,000

Investment in a bond issued by Maju Bhd

In this case, the cash flows deriving from the bond are not solely interest and principal.

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Tony Bhd hopes to profit from improving financial health of Maju Bhd, and therefore increased
market value, hence, amortised cost is not appropriate. Fair value through profit & loss
should be applied.

Question 4

Accounting Principle
According to MFRS132, compound instrument:
▪ Have both a liability and an equity component from the issuer's perspective (e.g.
convertible bonds)
▪ Requires that the component parts be accounted for and presented separately according to
their substance based on the definitions of liability and equity
▪ Split accounting at issuance

Accounting Treatment
- If this issuance is approved by the board, City is required to account for the convertible
debentures on initial recognition based on the substance and using split equity accounting.
- The net proceeds are recorded at RM44.55 million, after minus the transaction cost 1%.
- The liability is calculated on the assumption that there is no conversion option on the debt, so
treated as a 100% loan redeem for cash. Hence the initial liability is recognized at the present
value of the future cash flow, discounted at the rate of interest on similar debt without the
conversion version (i.e. 10%). This gives a figure of RM42.74 million.
- The difference between the liability and proceeds is recognized within equity at
RM2.26million.
- The transaction cost of RM0.45 will be split between the liability and equity in proportion to
the weighting of the liability and equity.
o Liability = 42.74- 1% = 42.31
o Equity = 2.26 – 1% = 2.24
- There will have the unwinded interest for these 3 years and this interest will be charged to the
SOPL from 2020 to 2022.

Impact to FS
- When City has this new issue, City needs to bear more interest cost in 2020 despite the bank
loan.

Working
Proceed 450
RM45m x 8% x 0.909 3.27
RM45m x 8% x 0.826 2.97
RM45m x 8% x 0.751 2.70
RM45m x 0.751 33.80 42.74
2.26