FAC4861/103/0/2021

NFA4861/103/0/2021
ZFA4861/103/0/2021

Tutorial letter 103/0/2021

ADVANCED FINANCIAL ACCOUNTING I

FAC4861/ZFA4861/NFA4861

Year Module

Department of Financial Governance

IMPORTANT INFORMATION:

This tutorial letter contains important information

about your module.
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INDEX Page

Due date 3

Personnel and contact details 3

Prescribed method of study 3

Suggested working programme 4

Learning unit 7 Financial instruments 5

Self assessment questions and suggested solutions 33

THEORY QUESTIONS

Marks are awarded for applying the theory to the content of the question. No marks are
awarded for writing the theory from the Accounting Standards.

Please note if theory is included in any solution, it is there for guidance purposes only.
Kindly note no marks are awarded for the theory.

Write neatly, use bullet points where possible and ensure to obtain the presentation
marks!

MJM
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DUE DATE
TEST 2 ON TUTORIAL LETTER 103: 18 MAY 2021

REMARK DEADLINE: 19 JUNE 2021

PERSONNEL AND CONTACT DETAILS

Personnel Telephone
Number
Lecturers
Ms K Mohajane (Module Coordinator) 012 429 4688
Ms Y Abed 012 429 4713
Mr H Meyer 012 429 4722
Ms L Thindisa 012 429 8225
Ms A Uys 012 429 4750
Ms M Pholo 012 429 8767
Mr Y Madolo
Mr C Ngele

Please send all e-mail queries to: [email protected]

PRESCRIBED METHOD OF STUDY

1. Please read the prescribed study material for every learning unit thoroughly before you study the
information in the learning unit.

2. Do the other questions (section B) in the learning unit and make sure you understand the principles
contained in the questions.

3. Consider whether you have achieved the specific outcomes of the learning unit.

4. After completion of all the learning units - attempt the self-assessment questions to test whether you
have mastered the contents of this tutorial letter.

MJM
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SUGGESTED WORKING PROGRAMME

MAY 2021
TUESDAY WEDNESDAY THURSDAY FRIDAY SATURDAY SUNDAY MONDAY
11 12 13 14 15 16 17
Financial Financial Financial Financial Self Self Self
instruments instruments Instruments Instruments assessment assessment assessment
questions questions questions

MJM
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LEARNING UNIT 7 – FINANCIAL INSTRUMENTS

INTRODUCTION

Financial instruments include a wide variety of instruments, including shares, debentures,

receivables, payables and derivative instruments (for example share options and forward
exchange contracts). The accounting treatment and disclosure of financial instruments
are prescribed in three standards:

• IAS 32 Financial instruments: Presentation

• IFRS 9 Financial instruments
• IFRS 7 Financial instruments: Disclosures

OBJECTIVES/OUTCOMES

After you have studied this learning unit, you should be able to do the following:

1. Identify and account for financial assets and liabilities.

2. Measure financial assets and liabilities on initial recognition and subsequently.

3. Understand when a reclassification may be made and to reclassify financial assets

between different categories.

4. Account for the impairment of financial assets.

5. Account for the derecognition of financial assets and liabilities.

6. Distinguish between equity and liabilities.

7. Account for share buy-backs and treasury shares.

8. Understand when it is allowed to off-set financial assets and liabilities.

9. Identify and account for derivatives.

10. Disclose financial instruments in the financial statements.

PRESCRIBED STUDY MATERIAL

The following must be studied before you attempt the questions in this learning unit:

1. IAS 32 Financial Instruments: Presentation

2. IFRS 9 Financial Instruments

3. IFRS 7 Financial Instruments: Disclosure

4. Chapter on financial instruments in Descriptive Accounting, 21st edition

MJM
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THE REST OF LEARNING UNIT 7 IS BASED ON THE ASSUMPTION THAT YOU

HAVE ALREADY STUDIED THE RELEVANT CHAPTERS IN THE PRESCRIBED
STUDY MATERIAL.

SECTION A - ADDITIONAL INFORMATION

1. OVERVIEW OF IAS 32

Financial instrument: Presentation IAS 32 SAICA Level Questions and Examples

Learning IAS
Unit 7 Standard
11 Core
Definitions

Financial instruments 7.1

Financial assets 7.1
Financial Liability 7.1
Equity instrument 7.1

Core
Liabilities and Equities 15-16 7.1
No contractual obligation to deliver 17-20
cash or another financial asset 7.1

Settlement in the entity’s own equity 22-27

instrument
- variable number of its own 21
Presentation

7.1
equity instruments
- fixed number of its own equity 22
instruments
Contracts (options) on own equity Awareness
instruments
Contingent settlement provisions 25
Compound financial instrument 28-32 7.1-7.2
Treasury shares 33 7.1 IE 9
Interest, dividends, losses and gain 35-37
Offsetting a financial asset and a
42
financial liability

The following concepts and topics of IAS 32 Financial Instruments: Presentation excluded from
syllabus:

Concepts and topics (IAS 32) Level of examination

Definitions:
• Purchased or originated credit-impaired financial assets Excluded
• All definitions relating to hedge accounting Excluded
Presentation:
• Puttable instruments and obligations arising on liquidation Excluded
(par. 16A-16F & 22A)
Application guidance and Illustrative Examples follow the related levels of
the main body in the standard.

MJM
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2. OVERVIEW OF IFRS 9

Financial Instruments IFRS 9 SAICA Questions and

Level Examples
Learning IFRS
Unit 7 Standard
Appendix A Core
12-month expected credit losses
Amortised cost
Credit impaired financial asset
Credit loss
Derivative 7.4
Definitions

Effective interest rate

Expected credit losses
Financial liability at FVTPL
Gross carrying amount of financial asset
Held for trading
Loss allowance
Modification gair or loss
Transaction costs

Initial recognition 3.1.1 Core 7.2

Recognition and
derecognition

- First-day gains and losses Awareness 7.2

Derecognition of financial assets 3.2.1–3.2.9 Core
3.3.1 & 3.3.3 Core
Derecognition of financial liability
– 3.3.5
- Exchange of debt instrument 3.3.2 Awareness

Financial assets 4.1 Core

- At amortised cost 4.1.2 7.2 B.26
- At FVTOCI 4.1.2.A 7.2
Classification

- At FVTPL 4.1.4-5 7.2

Financial liabilities 4.2.1 Core

- At FVTPL

Embedded derivatives 4.3.1 Core

Reclassification 4.4.1 Awareness 7.2

MJM
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Financial Instruments IFRS 9 SAICA Questions and

Level Examples
Learning IFRS
Unit 9 Standard
Initial measurements 5.1 Core 7.2-7.3

Subsequent measurements 5.2 Core

-financial assets 7.2-7.3
-financial liabilities 5.3 Core 7.2

Amortised cost 5.4 Core

-Modifications 5.4.3 Awareness
-Write offs 5.4.4 Awareness

Impairments 5.5 Core

Measurement

Recognition of expected credit losses 5.5.1-8 7.2-7.3;

Identify when significant increase in credit 5.5.9-11 Awareness
risk or when credit impaired
Modified financial assets 5.5.12 7.3
Simplified approac 5.5.15-16 7.2
Measurement of expected credit losses 5.5.17-20 7.2-7.3;

Awareness
Reclassification of financial assets 5.6 7.2

Gains and losses 5.7 Core

-Investments in equity instruments
-Liabilities at FVTPL
-Assets at FVTOCI

The following concepts and topics of IFRS 9 Financial Instruments excluded from syllabus:

Concepts and topics (IFRS 9) Level of examination

Definitions:
• Purchased or originated credit-impaired (POCI) financial assets Excluded
• All definitions relating to hedge accounting Excluded
Initial recognition:
• Regular way purchase or sale of financial assets (trade date and Excluded
settlement date accounting).
Derecognition of financial assets:
• Transfers/continued involvement and applying the requirements to a Excluded
part or a whole
Classification of financial liabilities:
• Financial guarantee contracts Excluded
• Loan commitments Excluded
Embedded derivatives (only pertains to liabilities) Excluded
Hybrid instruments where the host is not a financial instrument Excluded
Initial measurement:
• Regular way purchase or sale of financial assets (trade date and Excluded
settlement date accounting).
Impairment:
• Purchased or originated credit-impaired financial assets Excluded
Hedge Accounting Excluded
Application guidance and Illustrative Examples follow the related levels of
the main body in the standard.

MJM
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Certain aspects of contractual cash flows that are ‘solely payments of Excluded
principal and interest‘ on the principal amount outstanding (SPPI criterion):
• Anything pertaining to negative or inverse interest rates
• B4.1.20 – B4.1.26 Contractually linked instruments
• B5.4.2 Commitment fees
• B5.4.3 & 4 Monthly fees

IFRS 7 Financial Instruments: Disclosure is at a core level to the extent that it supports concepts and
topics included in the financial accounting syllabus.

The concepts and topics of IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments is at
core level.

Forward exchange contract

A forward exchange contract (FEC), commonly known as a FEC or forward cover, is a contract
between a bank and its customer, whereby a rate of exchange is fixed immediately, for the buying
and selling of one currency for another, for delivery at an agreed future date. Economic, technical
and political factors can cause upheaval in the foreign exchange market, resulting in volatile
exchange rates that can hamper international trade. The forward exchange contract (FEC) is an
effective hedging tool tantamount to an insurance policy, in that it protects traders and clients from
unfavourable exchange rate fluctuations which might occur between the contract date and the
payment date.

Forward exchange contract is a derivate (not a hedging instrument) and therefore included in the
syllabus. Refer to IFRS 9 Financial Instruments Appendix A for the definition of a derivative.

MJM
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SECTION B - ADDITIONAL QUESTIONS

QUESTION 7.1 (59 marks)

The financial directors of Global Ltd (Global) and Excel Ltd (Excel) requested you to explain to them
how the following financial instruments should be classified in the financial statements of Global and
the financial statements of Excel in terms of IAS 32 Financial Instruments: Presentation. All the
transactions below occurred during the financial year ended 31 December 20.13.

Transaction 1

On 1 January 20.13 Global purchased 100 000 ordinary shares in Excel. These were acquired at fair
value on transaction date.

Transaction 2

On 1 December 20.13 Global obtained a short-term loan of R20 000 from Excel and is required to
repay the total loan within 90 days. The loan is still outstanding on 31 December 20.13.

Transaction 3

On 1 December 20.13 Global obtained a short-term loan of R20 000 from Excel and is required to
settle the total loan within 90 days in as many shares as equal to R20 000. The loan is still
outstanding on 31 December 20.13.

Transaction 4

On 1 December 20.13 Global issued share options to Excel. The share options entitle Excel to
purchase 2 000 ordinary shares in Global at a price of R2 per share.

Transaction 5

On 31 December 20.13 Global issued 1 000 redeemable cumulative preference shares to Excel at
an issue price of R1 per preference share. The dividend rate is an 8% cumulative preference
dividend per annum calculated on the issue price. All accumulated (unpaid) dividends will roll up until
redemption date. The redemption of preference shares will take place on 31 December 20.15 at
R1,20 per share.

Transaction 6

On 31 December 20.13 Global issued 1 000 non-redeemable cumulative preference shares to Excel
at an issue price of R1 per preference share. The dividend rate is an 8% cumulative preference
dividend per annum calculated on the issue price. The payment of a preference dividend is solely at
the discretion of the directors of Global.

Transaction 7

On 31 December 20.13 Global issued 1 000 cumulative compulsory convertible preference shares to
Excel at an issue price of R1 per preference share. On 31 December 20.15, the conversion date,
each preference share will automatically be converted into two ordinary shares. The dividend rate is
an 8% cumulative preference dividend per annum calculated on the issue price. All accumulated
(unpaid) dividends will roll up until conversion date.

MJM
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Transaction 8

On 1 January 20.13 Global issued 500 debentures to Excel. Each debenture will be converted into
one ordinary share on 1 January 20.15 if the revenue of Global increases by more than 8% per
annum. If the increase in Global’s revenue is less than 8% per annum, the debentures will be
redeemed in cash on 1 January 20.15.

Transaction 9

On 1 January 20.13 Global has 80 000 ordinary shares in issue which were originally issued at
R5 each. On 1 July 20.13 10 000 of the ordinary shares were bought back from Excel at R6 per
share.

REQUIRED
Marks
Provide an explanation to the financial directors of Global Ltd and Excel Ltd of how the 59
above mentioned financial instruments should be classified in their respective financial
statements for the year ended 31 December 20.13 in accordance with
IAS 32 Financial instruments: Presentation.

Please note:

• You are not required to include calculations in your explanation.

• Ignore the effect of the time value of money in the scenarios above.
• Ignore any normal income tax implications.
• Ignore any Value Added Tax (VAT) implications.
• Your answer must comply with International Financial Reporting Standard (IFRS).

MJM
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QUESTION 7.1 - Suggested solution

Transaction 1
Global’s financial statements (investor):
The investment in ordinary shares will be classified as a financial asset since Global holds the
equity instrument of another entity (IAS 32.11). (1)

Excel’s financial statements (issuer):

The ordinary shares issued will be classified as equity instruments since it is a contract that
evidences a residual interest in the assets of Excel after deducting its liabilities (IAS 32.11). (1)

Transaction 2
Global’s financial statements:
A loan payable will be recognised as a financial liability as Global has a contractual
obligation to deliver cash to Excel within 90 days (IAS 32.11). (1)

Excel’s financial statements:

A loan receivable will be recognised as a financial asset in the records of Excel as it
represents a contractual right to receive cash from Global (IAS 32.11). (1)

Transaction 3
Global’s financial statements:
In terms of the agreement, Global has no contractual obligation to deliver cash or another
financial asset to settle the loan. (1)
Global is however required to settle the loan with its own shares (equity instruments). It is
important to note that the fact that Global is required to deliver its own equity instruments does
not automatically classify the loan as an equity instrument (IAS 32.21). (1)
It is essential to determine the substance of the contract. In other words, is the number of
shares to be issued by Global in terms of the contract fixed or variable? (IAS 32.21) (1)
The amount that Global needs to settle remains fixed at R20 000. However, the number of
shares that Global will need to deliver to settle the loan varies (the number of shares issued on
delivery date is dependent on the share price of the ordinary shares). (1)
The contract will therefore be settled by delivering a variable number of Global’s own shares
in exchange for a fixed amount. Accordingly the loan payable is a financial liability
(IAS 32.11). (1)

Excel’s financial statements:

A loan receivable will be recognised as a financial asset as it meets the definition of a
financial asset (Excel receives an equity instrument from another entity) (IAS 32.11). (1)

Transaction 4
Global’s financial statements (issuer):
Global has no contractual obligation in terms of the option contract to deliver cash or
another financial asset to Excel. (1)
The issued share options however give Excel the right to buy a fixed number of Global’s
shares (2 000 ordinary shares) at a fixed price (R2 per ordinary share) (IAS 32.16 and
IAS 32.22). (1)
Accordingly the share options issued by Global are equity instruments in accordance with
IAS 32.22. (1)

MJM
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Excel’s financial statements (holder):

The share options meet the definition of a derivative (IAS 32.AG15 and IFRS 9 Appendix A)
from Excel’s perspective. (1)
The investment in the shares will only be recognised as a financial asset of Excel when the
share options are exercised (IAS 32.AG17). (1)

Transaction 5
Global’s financial statements (issuer):
Gobal Ltd should consider the two cash flow streams (components) related to preferences
shares (i.e. the payment of preference dividends and the payment of the principal amount)
separately for classification purposes (IAS 32.15). (1)

Principal amount
When assessing the substance of the agreement between Global and Excel, it is clear that
Global has a contractual obligation to deliver cash to Excel on 31 December 20.15 (the
preference share agreement contains a mandatory redemption feature) (IAS 32.18(a)). (1)
The principal amount therefore contains a financial liability. (1)

Dividends
It has to be determined if Global has a contractual obligation to make dividend payments to
assess if the dividend component of this agreement is equity or a financial liability. (1)
Cumulative dividends accumulate (accrue) if the company does not earn sufficient profits to
declare and pay a preference dividend i.e. if the dividend is not declared in one year it will be
carried forward to successive years. (1)
Since this preference share agreement contains a redemption feature, all accumulated
(unpaid) dividends will roll up until redemption date and will have to be paid on
31 December 20.15 when the preference shares are redeemed. (1)
Therefore based on the substance of this transaction, Global has a contractual obligation to
declare and pay all preference dividends on or before 31 December 20.15. (1)
In light of the above the preference dividends contain a financial liability. (1)

Conclusion
The preference shares are classified as a financial liability (IAS 32.11 and IAS 32.18a). (1)
Take note that the dividends paid to Excel will be recognised in profit or loss as finance costs
since the classification of the financial instrument determines how the related payment will be
treated in the financial statements. (1)

Excel’s financial statements (holder)

The investment in the preference shares will be classified as a financial asset in the records
of Excel. (1)

Transaction 6
Global’s financial statements (issuer).
As with the above transaction, if we evaluate the two cash flow streams related to
preferences shares we can conclude the following: (1)

Principal amount
Non-redeemable preference shares are preference shares that do not have a maturity date
and will therefore not be bought back by the issuer (Global) (also known as perpetual (1)
preference shares).This feature makes non-redeemable preference shares very similar to
equity. (1)

MJM
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Dividends
The cumulative dividends accumulate (accrue) if the company does not earn sufficient profits
to declare and pay a preference dividend. (1)
Since the non-redeemable preference shares do not contain a redemption obligation and the
payment of preference dividends are at the directors’ discretion, the preference shares
establish no contractual right to a preference dividend (IAS 32.AG26). (1)
Accordingly the preference dividends are similar to ordinary dividends (equity). (1)

Conclusion
Accordingly the preference shares should be classified as equity instruments. (1)

Excel’s financial statements (holder)

The investment in the preference shares will be classified as a financial asset in the records
of Excel as it is an equity instrument of another entity. (1)

Transaction 7
Global’s financial statements (issuer):
The two cash flow streams (components) related to preferences shares (i.e. the payment of
preference dividends and the payment of the principal amount) are considered separately for
classification as equity or a financial liability (IAS 32.15). (1)

Principal amount
The substance of this agreement between Global and Excel contains a compulsory
conversion feature that will force Global to convert the preference shares into ordinary shares
on 31 December 20.15. (1)
Therefore in terms of the agreement, Global has no contractual obligation to deliver cash or
a financial asset to Excel on conversion date. (1)
Global is however required deliver its own shares (equity instruments) to Excel on
conversion date. (1)
The substance of the contract determines that Global has to deliver a fixed number of
ordinary shares to Excel on conversion date (20 000 ordinary shares). (1)
In light of the above, the principal amount contains an equity instrument. (1)

Dividends
It has to be determined if Global has a contractual obligation to make dividend payments to
assess if the dividend component of this agreement is equity or a financial liability. (1)
Since this preference share agreement contains a compulsory conversion feature, all
accumulated (unpaid) dividends will roll up until conversion date and will have to be paid on
31 December 20.15 when the preference shares are converted. (1)
Therefore based on the substance of this transaction, Global has a contractual obligation to
declare and pay all preference dividends on or before 31 December 20.15. (1)
In light of the above, the preference dividends contain a financial liability. (1)

Conclusion
The preference shares are classified as a compound financial instrument as it contains
both an equity and a liability component (IAS 32.28). (1)
This would lead to a “split accounting” treatment whereby at issue date the net present value
of the amount payable to Excel will be classified as a liability and the balance of the
proceeds received on issue date will be classified as equity (IAS 32.32). (1)

Excel’s financial statements (holder)

The investment in the preference shares will be classified as a financial asset in the records
of Excel as it is a contractual right to receive cash or another financial asset. (1)

MJM
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COMMENT

If the convertible preference shares are not compulsory convertible but convertible
at the option of the holder at any time up to maturity, the preference shares will
still be classified as a compound financial instrument for the following reasons:
• Global has a contractual obligation to declare and pay all accumulated
preference dividends when Excel exercises its option to convert to ordinary
shares (financial liability component).
• If Excel does not exercise its option to convert to ordinary shares, Global will
have to redeem the preference shares on 31 December 20.15 (financial liability
component).
• Excel has a call option (the right to exchange the preference shares for fixed
number of ordinary shares) at any time before maturity date (equity
component).

Transaction 8
Global’s financial statements (issuer):
The obligation attached to the debentures (settling in cash or by issuing equity instruments) is
dependent on the occurrence or non-occurrence of uncertain future events. (1)
It has to be determined if the uncertain future event (the rise in future revenue) is within the
control of Global and Excel. (1)
In terms of IAS 32.25 the issuer’s future revenues are not within the control of the issuer
and the holder. (1)
In light of this, Global does not have an unconditional right to avoid delivering cash on maturity
date. (1)
Therefore the debentures are classified as a financial liability in terms of the contingent
settlement provisions of IAS 32.25. (1)

Excel’s financial statements (holder):

The investment in the debentures will be classified as a financial asset in the records of Excel
since Excel has a contractual right to receive cash. (1)

Transaction 9
Global’s financial statements (issuer):
Global reacquired its own equity instruments and hold these shares as an investment in itself
(referred to as “treasury shares”). (1)
In terms of South African legislation the shares reacquired by Global must be cancelled as
issued share capital. (1)
An amount equal to the initial proceeds of the shares (10 000 x R5 = R50 000) is debited to
the share capital account in Global’s financial statements. (1)
No gain or loss is recognised in profit or loss on the share buy-back. (1)
The remaining R10 000 (R60 000 – R50 000) is debited to any available equity reserve in
Global’s financial statements (including retained earnings) (IAS 32.33). (1)

Excel’s financial statements (holder):

Before the share buy-back, the investment in equity instruments is classified by Excel as a
financial asset. The share buy-back transaction is accounted for as a disposal of a financial
asset. (1)
Total (59)

MJM
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QUESTION 7.2 (72 marks)

Spilkin Ltd has a 31 December year end. The following transactions relate to Spilkin Ltd:

Transaction 1

Spilkin Ltd acquired 20 000 shares in Invest Ltd for R12,50 per share on 1 June 20.12.

Transaction costs amounted to R2 500. The fair value of these shares as at 31 December 20.12
was R11,00 per share and R11,50 as at 31 December 20.13.

Transaction 2

Spilkin Ltd acquired 30 000 Rich Ltd shares for capital appreciation purposes for R10,50 per
share on 1 January 20.11. Transaction cost amounted to R3 000. The fair value of these shares
as at 31 December 20.11 was R9,50 per share. As at 31 December 20.12 the share price
decreased to R7,00 per share. At 31 December 20.13 the share price improved to R11,00 per
share. Spilkin Ltd elected in terms of IFRS 9.5.7.5 to present subsequent changes in the fair
value of the shares in other comprehensive income.

Transaction 3

On 1 August 20.13 Spilkin Ltd disposed of an investment in Silver Ltd at fair value for R160 000.
The costs related to the disposal of the investment amounted to R1 500. The investment in Silver Ltd
was an investment in equity shares and was not held for trading purposes. The management of
Spilkin Ltd irrevocably elected on initial recognition to present subsequent changes in the fair value
of this investment in other comprehensive income in terms of IFRS 9.5.7.5. The investment in Silver
Ltd was acquired on 1 January 20.13 for an amount of R150 000.

Transaction 4

Convertible debentures amounting to R250 000 were issued on 1 January 20.12 by Spilkin Ltd.
The debentures have a nominal value of R2 per debenture and pay interest at 14% per annum
until conversion. The debentures are convertible into ordinary shares at a rate of one share for
one debenture at the option of the debenture holders at any time before 31 December 20.16. A
fair interest rate for similar debentures without conversion rights is 16%.

Transaction 5

Spilkin Ltd purchased 10 000 listed debentures at R80 per debenture (face value) on
1 January 20.12. The fair value of the debentures was R877 109 on 1 January 20.12. The
debentures bear interest at 10% per annum, payable annually on 31 December. Transaction
costs amounted to R2 000. The investment in debentures matures after 10 years at face value.
The company’s business model is to hold the investment in debentures to collect contractual
cash flows of interest and the principal amount.

On 1 January 20.12 Spilkin Ltd assessed the probability that the counterparty might default on
payments and estimated the 12-month expected credit losses to be R 2 500. At 31 December 20.12
there has been no significant deterioration in the credit quality of Pearl Ltd and the 12-month
expected credit losses is estimated to be R 3 500.

At 31 December 20.13 there was a significant deterioration in the credit quality of the counterparty
however there was no default of the payment of interest. Spilkin Ltd determined that there is a
significant increase in the credit risk of Pearl Ltd and estimated that the lifetime expected credit
losses on the debentures amounted to R28 500 at 31 December 20.13. On this date the investment
in debentures is not credit impaired.

MJM
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Transaction 6

Spilkin Ltd purchased debentures at a fair value of R877 109 on 1 January 20.13. Transaction
costs amounted to R2 000. The investment in debentures has a face value of R1 000 000 and
carries interest at 8% per annum, payable annually on 31 December. The investment in
debentures matures after 10 years at face value. The investment debentures is held within a
business model of which the objective is to collect contractual cash flows and when an opportunity
arises it will sell the debentures to re-invest the cash in other debentures with a higher return. In
other words, both collecting contractual cash flows and selling the debentures are integral to
achieving the business model’s objectives.

On 1 January 20.13 Spilkin Ltd assessed probability that the counterparty might default on payments
and estimated the 12-month expected credit losses to be R2 000. At 31 December 20.13 there has
been no significant deterioration in the credit quality of Spilkin Ltd and the 12-month expected credit
losses is estimated to be R2 500 on this date. The total investment in debentures was sold at
31 December 20.13 for cash at its fair value of R895 000.

Transaction 7

Spilkin Ltd has a portfolio of trade receivables of R5 430 000 at 31 December 20.13 and only
operates in one geographical region. The trade receivables do not have a significant financing
component in accordance with IFRS 15 Revenue from Contracts with Customers. To determine the
expected credit losses for the trade receivables, Spilkin Ltd uses a provision matrix. The provision
matrix is based on its historical observed default rates over the expected life of the trade receivables
and is adjusted for forward-looking estimates. Spilkin Ltd uses the following provision matrix:

Current 1-30 days 31-60 days 61-90 days More than

past due past due past due 90 days
past due
Default rate 0,3% 1,1% 3,1% 6% 13%

The age analysis of the trade receivables is as follows:

Gross
carrying
amount
Current 4 072 500
1-30 days past due 543 000
31-60 days past due 362 000
61-90 days past due 271 500
More than 90 days past due 181 000
Total 5 430 000

Transaction 8

Spilkin Ltd borrowed R98 500 cash from Bass Bank Ltd on 1 January 20.13. The loan is repayable in
four equal instalments of R33 475 at the end of each year.

On 31 December 20.13, after paying the first instalment, Spilkin Ltd was able to renegotiate the
terms of the loan payable in order to improve its cash position for the next three years. Spilkin Ltd
issued 10 000 of its own ordinary shares as full and final settlement of the loan payable. The quoted
price (level 1 input) of one Spilkin Ltd share on 31 December 20.13 amounted to R8,00.

MJM
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REQUIRED
Marks
(a) Provide all the journal entries in the records of Spilkin Ltd since acquisition or 63
issue date of the financial instrument until 31 December 20.13 for transactions
1 to 6.

(b) Provide the journal entries in the records of Spilkin Ltd to account for the loss 9
allowance on the trade receivables (transaction 7) for the year ended
31 December 20.13 and the settlement of the loan from Bass Bank Ltd
(transaction 8) on year ended 31 December 20.13.

Please note:

• Ignore any normal income tax implications.

• Ignore any Value Added Tax (VAT) implications.
• Round off all effective interest rates to four decimals.
• Round off all calculated amounts to the nearest Rand.
• Your answer must comply with International Financial Reporting Standards
(IFRS).

MJM
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QUESTION 7.2 - Suggested solution

Transaction 1
Dr Cr
R R
1 June 20.12
J1 Financial asset at fair value through P/L (SFP) 250 000 (½)
Transaction costs (P/L) 2 500 (½)
Bank (SFP) [(20 000 x 12,50) + 2 500] 252 500 (2)
Initial recognition of investment in shares and transaction costs
31 December 20.12
J2 Fair value adjustment (P/L) [(20 000 x 11) – 250 000] 30 000 (1½)
Financial asset at fair value through P/L (SFP) 30 000 (½)
Fair value adjustment at year end
31 December 20.13
J3 Financial asset at fair value through P/L (SFP) 10 000 (½)
Fair value adjustment (P/L) [(20 000 x 11,50) – 220 000] 10 000 (1½)
Fair value adjustment at year end
Total (7)

COMMENT

This investment is classified as a financial asset at fair value through P/L. Take note
that transaction costs are expensed and not included in the carrying amount of the
investment in terms of IFRS 9.5.1.1.

Transaction 2

1 January 20.11
Financial asset at fair value through OCI (SFP) 318 000
J1 Bank (SFP) [(30 000 x 10,50) + 3 000] 318 000 (½)
Initial recognition of investment in shares and transaction costs (2)
31 December 20.11
J2 Mark-to-market reserve (OCI)
[(30 000 x 9,50) - 318 000 (J1)] 33 000 (1½)
Financial asset at fair value through OCI (SFP) 33 000 (½)
Fair value adjustment at year end
31 December 20.12
J3 Mark-to-market reserve (OCI) 75 000 (1½)
[(30 000 x 7) – 285 000 (J1+J2)]
Financial asset at fair value through OCI (SFP) 75 000 (½)
Fair value adjustment at year end
31 December 20.13
J4 Financial asset at fair value through OCI (SFP)
[(30 000 x 11) – 210 000 (J1+J2+J3)] 120 000 (1½)
Mark-to-market reserve (OCI) 120 000 (½)
Fair value adjustment at year end
Total (8½)

MJM
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COMMENT

This investment is classified as a financial asset at fair value through OCI since the
management of Spilkin Ltd made the election in terms of IFRS 9.5.7.5. Take note that
management may only make this election if the investment is an equity instrument and
if it is not held for trading. In this case the transaction costs should be capitalised to the
investment.

Transaction 3
Dr Cr
R R
1 January 20.13
J1 Financial asset at fair value through OCI (SFP) 150 000 (1)
Bank (SFP) 150 000 (½)
Acquisition of investment in Silver Ltd
1 August 20.13
J2 Financial asset at fair value through OCI (SFP)
(160 000 – 150 000) 10 000 (1)
Mark-to-market reserve (OCI) 10 000 (½)
Remeasurement of investment to fair value on date of
sale
J3 Bank (SFP) (160 000 – 1 500) 158 500 (1)
Selling expenses (P/L) 1 500 (1)
Financial asset at fair value through OCI (SFP) 160 000 (1)
Sale of investment in Silver Ltd
Total (6)

COMMENT
The investment is revalued to its new fair value on the selling date (prior to
derecognition). The fair value gains/losses on the investment in Silver are recognised in
other comprehensive income but the selling expenses are recognised in profit or loss.
The cumulative fair value gains/losses presented in OCI through the mark-to-market
reserve may not be transferred to profit/loss on selling date (IFRS 9 B5.7.1). However,
Spilkin may transfer the cumulative fair value gains/losses within equity (to retained
earnings for instance) (IFRS 9 B5.7.1). Since the question is silent in this regard, a
journal for the transfer of the cumulative fair value gains/losses is not required.

MJM
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Transaction 4 Dr Cr
R R

1 January 20.12
Bank (SFP) [C1] 250 000
J1 Liability component: debentures (SFP) [C1] 233 629 (½)
Equity component: debentures (SCE) [C1] 16 371 (2½)
Convertible debentures issued (1½)
31 December 20.12
J2 Finance costs (P/L) [C2] 37 381 (1)
Bank (SFP) [C2] 35 000 (½)
Liability component of convertible debentures (SFP)
[C2] 2 381 (1)
Recognise effective interest and interest paid
31 December 20.13
J3 Finance costs (P/L) [C2] 37 762 (1)
Bank (SFP) [C2] 35 000 (½)
Liability component of convertible debentures (SFP)
[C2] 2 762 (1)
Recognise effective interest and coupon interest paid
Total (9½)

COMMENT

• From Spilkin’s perspective the convertible debentures represent a compound

instrument and comprise two components: a financial liability (a contractual
obligation to deliver cash in the form of interest and principal) and an equity
instrument (option granting the holder the right to convert the debentures into
a fixed number of ordinary shares of Spilkin).
• The financial liability component of the convertible debentures is measured at
amortised cost using the effective interest rate method in terms of IFRS 9.
• It should be noted that it is not important which party has the option to
convert the debentures into ordinary shares. The issuer’s obligation to make
payments of interest and principal exists as long as the instrument is not
converted (irrespective of which party holds the option to convert).

CALCULATIONS

C1. Present value of liability portion of convertible debentures

N = 5 years [½]
I = 16% (market interest rate) [½]
PMT = 35 000 (250 000 x 14%) (coupon rate) [½]
FV = 250 000 [½]
PV = 233 629

Financial liability 233 629

Equity (balancing figure) 16 371 [1]
Total 250 000
[3]

MJM
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C2. Amortisation table of debentures issued

Effective Interest
Opening Closing
Date interest fixed cash
balance balance
16% p.a coupon

31 December 20.12 233 629 37 381 (35 000)1 236 010 [1]
31 December 20.13 236 010 37 762 (35 000) 238 772 [1]
[2]
1
250 000 x 14% = 35 000

Transaction 5
Dr Cr
R R
1 January 20.12
J1 Financial asset at amortised cost: debentures (SFP) 879 109 (½)
Day one gain on acquisition of debentures (P/L) 77 109 (1)
Bank (SFP) [(10 000 x 80) + 2 000] 802 000 (1½)
Initial recognition of investment in debentures at fair
value
J2 Expected credit loss (P/L) 2 500 (1)
Allowance for expected credit losses (SFP) (given) 2 500 (½)
Recognition of 12-month expected credit loss allowance
31 December 20.12
J3 Bank (SFP) [C1] 80 000 (1)
Financial asset at amortised cost: debentures (SFP)
(balancing) 5 334 (½)
Interest income (P/L) [C1] 74 666 (3)
Recognise effective interest income and interest income
received
J4 Expected credit loss (P/L) 1 000 (1)
Allowance for expected credit losses (SFP)
(3 500 – 2 500) 1 000 (1)
Recognition of 12-month expected credit loss

COMMENT

• The fair value of the debentures can be determined on initial recognition with
reference to quoted market prices for identical financial assets. However, the
fair value of the debentures and the transaction price are not equal, resulting in
a day one gain (or a loss in other circumstances).
• There was no significant increase in credit risk since initial recognition and
therefore 12-month expected credit losses are recognised at reporting date
(31 December 20.12).

MJM
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Dr Cr
R R
31 December 20.13
J5 Bank (SFP) [C1] 80 000 (1)
Financial asset at amortised cost: debentures (SFP)
(balancing) 5 788 (½)
Interest income (P/L) [C1] 74 212 (1)
Recognise effective interest income and interest income
received
J6 Expected credit loss (P/L) 25 000 (½)
Loss allowance on debentures (SFP) (28 500 – 3 500) 25 000 (1)
Recognition of lifetime expected credit losses
Total (15)

COMMENT

The credit risk has significantly increased since initial recognition and therefore, in
terms of IFRS 9.5.5.3., lifetime expected credit losses are recognised at reporting
date (31 December 20.13).

CALCULATIONS

C1. Investment in debentures

Effective interest rate

N = 10 years [½]
PV = (877 109 + 2 000) = (879 109) [½]
PMT = 80 000 (10 000 x 80 x 10%) (coupon rate) [½]
FV = 800 000 (10 000 x 80) [½]
I = 8,4933%

COMMENT

The investment in debentures is not credit impaired. Therefore the effective

interest rate of the debentures is calculated with reference to the gross carrying
amount of the debenture.

Amortisation table of investment in debentures

Gross Effective Gross

carrying Interest carrying
Interest
Date amount fixed at amount
Coupon
Opening 8,4933% Closing
balance balance

31 December 20.12 879 109 74 666 (80 000) 873 775 [1]
31 December 20.13 873 775 74 212 (80 000) 867 987 [1]
[4]

MJM
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EXAM TECHNIQUE

The effective interest is 8,4933% per annum. The effective interest income can be
calculated as follows for the financial year ended 31 December 20.12:

• 879 109 x 8,4933% = 74 666 or

• 1 amort interest on calculator.

To save time, in the exam or test situation the student can indicate the calculation of
interest as per the calculations indicated above instead of writing out an
amortisation schedule which can be time consuming.

Transaction 6
Dr Cr
R R
1 January 20.13
J1 Financial asset at fair value through OCI: debentures
(SFP) (877 109 + 2 000) 879 109 (1)
Bank (SFP) 879 109 (1)
Recognise investment and capitalise transaction costs
J2 Expected credit loss (P/L) 2 000 (1)
Expected credit loss reserve (OCI) 2 0001 (½)
Recognition of 12-month expected credit loss reserve
31 December 20.13
J3 Bank (SFP) [C1] 80 000 (1)
Financial asset at fair value through OCI: debentures
(SFP) (balancing) 7 598 (½)
Interest income (P/L) [C1] 87 598 (3)
Recognise effective interest income and interest income
received
J4 Expected credit loss (P/L) 500 (1)
Expected credit loss reserve (OCI)
(2 500 – 2 000) 1
500 (½)
Recognition of 12-month expected credit loss
J5 Financial asset at fair value through OCI: debentures
(SFP) 8 293 (1)
Fair value gain (OCI)
(886 707 [C1] – 895 000 (given)) 2
8 293 (1)
Remeasure investment to fair value
J6 Bank (SFP) 895 000 (1)
Financial asset at fair value through OCI:
debentures (SFP) 895 000 (1)
Sell investment in debentures for cash
J7 Fair value gain (OCI) 8 293 (1)
3
Fair value gain (P/L) 8 293 (1)
Reclassify fair value gain to profit or loss on
derecognition
3
J8 Expected credit loss reserve (OCI) 2 500 (1)
Expected credit loss (P/L) (500 + 2 000) 2 500 (½)
Reclassify loss to profit or loss on derecognition
allowance
Total (17)

MJM
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COMMENT
1
Expected credit losses are recognised in other comprehensive income when
those expected credit losses relate to a financial asset mandatorily measured
at fair value through other comprehensive income in terms of IFRS 9.4.1.2A.
2
The effective interest income recognised in 20.14 amounts to R85 514 and is
calculated using the original effective interest on the gross carrying amount
of the debentures (9,9644% × 886 707[C1]). The gross carrying amount is the
amortised cost of a financial asset, before adjusting for any loss allowance.
3
The cumulative fair value gain or loss and accumulated impairment amount
recognised in equity via other comprehensive income is recycled (transferred) to
profit or loss when the financial asset is derecognised

CALCULATIONS

C1. Investment in debentures

Effective interest rate

N = 10 years [½]
PV = (877 109 + 2 000) = (879 109) [½]
PMT = 80 000 (1 000 000 x 8%) (coupon rate) [½]
FV = 1 000 000 [½]
I = 9,9644%

Amortisation table of investment in debentures

Effective
Opening Interest Interest Closing
Date
balance fixed at coupon balance
9,9644%

31 December 20.13 879 109 87 598 (80 000) 886 707 [1]
[3]

Transaction 7
Dr Cr
R R
31 December 20.13
J1 Expected credit loss (P/L) [C1] 69 233 (3)
Loss allowance on trade receivables (SFP) 69 233 (½)
Recognition of lifetimeexpected credit losses
(3½)

COMMENT

In accordance with IFRS 9.5.5.15, the loss allowance for trade receivables is
always measured at an amount equal to the lifetime expected credit losses. A
provision matrix can be used to determine the amount of lifetime expected credit
losses on trade receivables.

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CALCULATIONS

C1. Loss allowance on trade receivables

Provision matrix

Gross Default Lifetime

carrying rate expected credit
amount loss allowance
R R
Current 4 072 500 0,3% 12 218 [½]
1-30 days past due 543 000 1,1% 5 973 [½]
31-60 days past due 362 000 3,1% 11 222 [½]
61-90 days past due 271 500 6% 16 290 [½]
More than 90 days past due 181 000 13% 23 530 [½]
Total 5 430 000 69 233 [2½]

Transaction 8
Dr Cr
R R
31 December 20.13
J1 Financial liability at amortised cost (SFP) [C1] 78 344 (3½)
Loss from derecognition of loan payable (P/L) (balancing) 1 656 (1)
Ordinary share capital (SCE) (10 000 x R8,00) 80 000 (1)
Derecognition of loan payable
(5½)
C1. Settlement with equity instruments

Effective interest rate

N = 4 years [½]
PV = (98 500) [½]
PMT = 33 475 [½]
FV = 0 [½]
I = 13,522%

Amortisation table of loan

Effective
Opening Interest Closing
Date Payment
balance fixed at balance
13,522%

31 December 20.13 98 500 13,319 (33 475) 78,344 [1]

[3]

COMMENT

The issue of an entity’s equity instruments to a credit to extinguish all or part of a

financial liability is seen as consideration paid. Spilkin Ltd will remove the loan
payable from its statement of financial position as the shares were issued as full
and final settlement of the loan payable (IFRIC 19).

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QUESTION 7.3 (15 marks)

Coffee Ltd purchased debentures at a fair value of R100 000 on 1 January 20.13. No
transaction costs were incurred by Coffee Ltd. The investment in debentures has a face value of
R100 000 and bears interest at 8% per annum, payable annually on 31 December. The
investment in debentures matures after five years at R110 000. The company’s business model
is to hold the investment in debentures to collect contractual cash flows of interest and the
principal amount.

On 1 January 20.13 Coffee Ltd assessed the probability that the counterparty might default on
payments and estimated the 12-month expected credit losses to be R2 500. On 31 December 20.13
Coffee Ltd assessed the increase in credit risk of the counterparty and determined the credit risk of
the debentures increased significantly since 1 January 20.13. The allowance for expected credit
losses equal to lifetime expected credit lossess was determined as R4 000 on 31 December 20.13.
The debentures were not credit-impaired on this date.

Management of Coffee Ltd renegotiated the terms of the contract with the counterparty on
1 January 20.14 and agreed to extend the term of the contract. The counterparty will continue to
pay the annual coupon interest rate at 8% per annum. The redemption amount will however be
paid on 31 December 20.19 at a value of R116 000. The gross carrying amount of the
debentures on 1 January 20.14, after the modification, was R101 948 and the effective interest
for the year ended 31 December 20.14 was R9 837. These amounts were correctly calculated
using the original effective interest rate.

Coffee Ltd determined on 31 December 20.14 that the credit risk of the debentures increased
significantly since initial recognition and therefore measured the lifetime expected credit losses at
R5 000. The debentures are not credit impaired on this date.

REQUIRED
Marks
Provide the journal entries relating to the investment in debentures in the records of 15
Coffee Ltd for the financial year ended 31 December 20.13 and 31 December 20.14.

Please note:

• Ignore normal income tax implications.

• Ignore Value Added Tax (VAT) implications.
• Round off all calculated effective interest rates to four decimals.
• Round off all calculated amounts to the nearest Rand; and
• Your answer must comply with International Financial Reporting Standards
(IFRS).

MJM
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QUESTION 7.3 – Suggested solution

Dr Cr
R R
1 January 20.13
J1 Financial asset at amortised cost: debentures (SFP) 100 000 (½)
Bank (SFP) 100 000 (1)
Recognise investment in debentures at fair value
J2 Expected credit loss (P/L) 2 500 (1)
Allowance for expected credit losses (SFP) 2 500 (½)
Recognition of 12-month expected credit loss
31 December 20.13
J3 Bank (SFP) [C1] 8 000 (1)
Financial asset at amortised cost: debentures (SFP)
(balancing) 1 650 (½)
Interest income (P/L) [C1] 9 650 (3)
Recognise effective interest income and coupon interest
received
J4 Expected credit loss (P/L) (4 000 (given) – 2 500 (given)) 1 500 (1)
Allowance for expected credit losses (SFP) 1 500 (1)
Recognition of lifetime expected credit losses after
modification
1 January 20.14
J5 Financial asset at amortised cost: debentures (SFP) 298 (½)
Modification gain (P/L) (101 650 – 101 948) 298 (1)
Modification gain recognised on modification of contractual
cash flows of the debentures
31 December 20.14
J6 Bank (SFP) 8 000 (1)
Financial asset at amortised cost: debentures (SFP)
(balancing) 1 837 (½)
Interest income (P/L) (given) 9 837 (1)
Recognise effective interest income and coupon interest
received
J7 Expected credit loss (P/L) (5 000 (given) – 4 000) 1 000 (1)
Allowance for expected credit losses (SFP) 1 000 (½)
Recognition of lifetime expected credit losses after
modification
Total (15)

COMMENT

The effective interest income for 20.14 is calculated using the original effective interest
rate on the new gross carrying amount (after modification) of the debentures.

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CALCULATIONS

C1. Investment in debentures

Effective interest rate

N = 5 years [½]
PV = (100 000) [½]
PMT = 8 000 (100 000 x 8%) [½]
FV = 110 000 [½]
I = 9,6495%

Amortisation table of investment in debentures before modification

(or use the AMORT function on your calculator)

Effective
Opening Interest Interest Closing
Date
balance fixed at coupon balance
9,6495%

31 December 20.13 100 000 9 650 (8 000) 101 650 [1]

[3]

MJM
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QUESTION 7.4 (13 marks)

Monster Machines Ltd is a manufacturing company located in Johannesburg. Monster Machines Ltd
manufactures machinery that is used in the construction industry. Most of the parts used by
Monster Machines Ltd in the manufacturing of the machines are imported from China.
Monster Machines Ltd are therefore severely impacted by the changes in exchange rates. As a
result, Monster Machines Ltd regularly enters into forward exchange contracts with a financial
institution to hedge itself against negative currency fluctuations. These forward exchange contracts
require no initial investment and is not settled at the end of the contract term.

Monster Machines Ltd has five directors. On 1 January 20.13 Monster Machines Ltd granted each
director 100 share options. Each option grants a director the right to receive one ordinary share
when the option is exercised. The options have to be exercised by the directors before
31 December 20.20. There are no vesting conditions attached to the options. The exercise price per
option is R4.

REQUIRED

Marks
(a) Discuss if the forward exchange contracts and the options granted to directors meet 7
the definition of a financial instrument in terms of IAS 32 Financial instruments:
Presentation.

(b) Discuss if the forward exchange contracts and the options granted to directors are 6
derivatives in terms of IFRS 9 Appendix A.

Please note:

• Ignore any normal income tax implications.

• Ignore any Value Added Tax (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

MJM
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QUESTION 7.4 - Suggested solution

(a) Financial instrument

A financial instrument is any contract that gives rise to a financial asset of one entity (½)
and a financial liability/equity instrument of another entity (IAS 32.11).

Forward exchange contract

• A forward exchange contract contains a contractual right or obligation on both (1)
parties to exchange a financial asset/liability (currency) at the end of the term of the
contract.
• If the exchange of currency is favourable to Monster Machine Ltd the FEC is (1)
classified as a financial asset (IAS 32.11) in the records of Monster Machines Ltd
and as a financial liability in the records of the financial institution.
• If the exchange of currency is unfavourable to Monster Machine Ltd the FEC is (1)
classified as a financial liability (IAS 32.11) in the records of Monster Machines Ltd
and as a financial asset in the records of the financial institution.
• The forward exchange contract therefore meets the definition of a financial (½)
instrument.

Share options
• Share options are contracts that give rise to an equity instrument or financial liability (½)
of Monster Machines Ltd.
• The substance of the option contract determines that Monster Machines has to (1)
deliver a fixed number of shares per option contract.
• The share options are therefore an equity instrument of Monster Machines Ltd
(IAS 32.22). (½)
• The share options will be a financial asset (investment) from the directors’ (½)
perspective.
• The share options therefore meet the definition of a financial instrument. (½)
Total (7)

(b) Derivative

A derivative is a financial instrument with the following characteristics:

• Its value changes in response to an underlying (a specified foreign exchange rate,
interest rate, commodity price, index etc.);
• It requires no or little initial investment; and
• It is settled at a future date.
(1)

Forward exchange contract (please see the comment box below)

• As determined in (a) above, the forward exchange contract is a financial instrument. (½)
• The value of the forward exchange contract changes as the spot rate and interest
rates of the underlying currencies (in this case the Rand and the Chinese
Yuan/Dollars) of the contract fluctuates. (½)
• Entering into a forward exchange contract requires no initial investment from
Monster Machines Ltd. (½)
• The underlying currencies will be exchanged at the end of the term of the contract
(net-settlement will take place between Monster Machines Ltd and the bank). (½)
• The forward exchange contract therefore meets the definition of a derivative. (½)

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Share options
• As determined in (a) above, the share options are financial instruments. (½)
• The fair value of the share options changes as the underlying share price of
Monster Machines Ltd changes. (½)
• The share options granted to the directors require no investment from either party. (½)
• The share options will be exercised by the directors at a future date (before
31 December 20.20). (½)
• The share options therefore meet the definition of a derivative. (½)
Total (6)

HOW DOES A FORWARD EXCHANGE CONTRACT (FEC) WORK?

• A party (Monster Machines Ltd) exposed to foreign currency risk enters into a contract
with a commercial bank.
• The bank agrees to buy/sell a certain amount in a foreign currency at a fixed
exchange rate on a specified date in the future to/from the other party
(Monster Machines Ltd).
• By entering into this type of contract with the bank, the company locks in the
exchange rate at which the company will buy/sell foreign currency at a future date.
• This “locked in” rate is called the forward rate of the FEC.
• The forward rate is determined by the bank based on prevailing spot exchange rates
and money market interest rates.
• By entering into an FEC, the company attempts to protect/insure itself against
unfavourable exchange rate fluctuations.
• There are no upfront costs or upfront investment for entering into the FEC.
• At the end of the term of the FEC, the contract is net-settled between the two parties.

HOW DOES A SHARE OPTION WORK?

• A share option is a contract between two parties in which the option buyer purchases
the right (but not the obligation) to buy/sell the underlying shares at a predetermined
price from/to the option seller within a fixed period of time.
• Therefore instead of buying the actual shares of the company
(Monster Machines Ltd), the directors are given an option to the buy the shares when
they want to (within a specific time frame).
• For this privilege of buying the share at a later date but at a price determined today
(issue date), the option holder may be required to pay an initial premium to the
company (Monster Machines Ltd). In this case, the directors are not required to pay a
premium to the company.
• The predetermined price of R4 per option (the price the contract will be settled at) is
called the “strike price” or “exercise price”.
• Employees or directors who have been granted share options hope that the share
price of the company will go up and that they will be able to "cash in" by exercising
(purchasing) the shares at the lower strike price as stipulated by the option contract.
After exercising the option (i.e. the underlying shares were purchased), the employee
is then able to sell the shares in the market at the current higher market price and
thereby make a profit.

MJM
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SELF ASSESSMENT QUESTIONS AND SUGGESTED SOLUTIONS

Question Question name Source Marks Topics covered Page

1 Zwonke Wonke Ltd Test 2/2020 40 Financial instruments 34

2 Macko Ltd Test 2/2019 40 Financial instruments 41

3 Stein Oops Ltd Test 2/2018 40 Financial instruments 49

4 Strawberry Ltd Test 2/2017 20 Financial instruments 59

5 Tsogamo Ltd Test 4/2016 18 Financial instruments 64

6 Ukhozi Transport Ltd Test 4/2015 38 Financial instruments 68

7 Giovanni Ltd Test 4/2014 26 Financial instruments 75

8 Electron Ltd Test 4/2013 20 Financial instruments 80

MJM
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QUESTION 1 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

IGNORE ALL TAX AND VAT IMPLICATIONS

You are a recently qualified chartered accountant. The chief financial officer of Zwonke Wonke Ltd
(ZW) requires your assistance with the finalisation the financial statements for the year ended
29 February 20.10 due to the illness of the current financial manager. ZW’s main business is the
selling of affordable home appliances. The company has a February financial year end. During your
discussion with the chief financial officer you noticed the following transactions were only partly
accounted for, or not accounted for at all, and that it requires your attention:

PART I

An extract of the following balances was presented to you:

Balance at 1 March 20.19 R

Ordinary share capital (1 000 000) 35 000 000

Retained earnings 11 500 000

Transaction 1: Ordinary share capital

On 1 September 20.19, ZW bought back 15% of its ordinary shares from shareholders at R40 per
share. On 31 August 20.19, ZW declared interim dividends of R0,55 per share to its existing
shareholders and a final dividend of R0,60 was declared to its shareholders on 29 February 20.20.

Transaction 2: Investment in shares (equity instruments)

On 1 March 20.19, ZW acquired 1 000 000 ordinary shares in Joko Ltd (Joko) for R3,50 per share.
The fair value of the shares on this date was R2 500 000. On 31 January 20.20, Joko repurchased
20% of their shares pro-rata from all the shareholders at its fair value. On 29 February 20.20, Joko
issued dividends of R0,70 per share to its existing shareholders.

ZW irrevocably elected in terms of IFRS 9.5.7.5 to present subsequent changes in the fair value of
the investment in the mark-to-market reserve.

ZW has a policy of reclassifying previous fair value adjustments to retained earnings upon
derecognition of the financial assets designated at fair value through OCI.

The following fair value schedule was made available to you:

Date Fair value

1 March 20.19 R2,50 per share

31 January 20.20 R2,85 per share
29 February 20.20 R3,30 per share

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Transaction 3: Investment in debentures

On 1 March 2018 ZW purchased 12 000 debentures from Homu Ltd (Homu) at a fair value of R35
per debenture. Transaction costs amounted to R10 000. Coupon interest of 9% is calculated on the
face value of the debentures and is paid annually in arrears. The debentures will be redeemed at
their face value of R42 each on 28 February 20.23. ZW anticipates capital expenditure in the near
future. The company’s business model is to hold the investment in debentures to collect contractual
cash flows and will sell the investment when the capital expenditure is required. The company
therefore measures the investment at fair value through other comprehensive income. The fair
values of the debentures were as follows on the respective dates:

Date Fair value Assessed credit risk 12-month Lifetime

per expected expected credit
debenture credit losses losses
R R R

1 March 20.18 35 Low 32 400 64 500

28 February 20.19 36 Low 34 600 90 000
29 February 20.20 38 High (not credit-impaired) 39 000 105 000

On 29 February 20.20 ZW sold 3 000 of its debentures at its fair value. The accountant of ZW has
processed the following journal entries with regards to the investment:

Dr Cr
R R
1 March 20.18
Investment in debentures (SFP) (12 000 x 35)
J1 Transaction costs (P/L) 420 000
Bank (SFP) 10 000
Recognition of investment and transaction costs 430 000
J2 Impairment loss (P/L) 32 400
Allowance for expected credit losses (SFP) 32 400
Recognition of 12-month expected credit loss
28 February 20.19
J3 Bank (SFP) (12 000 x 42 x 9%) 45 360
Investment in debentures (SFP) 45 360
Recognise coupon interest received
J4 Investment in debentures (SFP) 12 000
Fair value adjustment (P/L)
(R36 – 35) x 12 000 12 000
Adjustment of an increase in fair value
J5 Impairment loss (P/L) 2 200
Allowance for expected credit losses (SFP)
(34 600– 32 400 [J2]) 2 200
Adjustment of allowance for expected credit losses

Note:

ZW has not processed any journal entries relating to the investment in debentures or the accounting
of the effective interest on the investment for the year ended 29 February 20.20.

The profit before tax for the year ended 29 February 20.20 amounted to R19 500 000 before the
above information has been taken into account:

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PART II

Transaction 4: Loan

On 1 March 20.19 ZW acquired a loan of R2 000 000 at its fair value from Charter Bank Ltd. At Initial
recognition this loan was correctly designated as a liability at fair value through profit or loss since
this designation eliminates or significantly reduces any accounting mismatch. You may assume that
the separation of this liability’s credit component will not create or enlarge an accounting mismatch.
The interest rate is 9,5% p.a., payable on February each year and the loan amount will be repaid at
a premium of R2 300 000 on 29 February 20.23. The fair value of the loan decreased to R1 800 000
million on 29 February 20.20. On 1 March 20.19 the repo rate, which is the observable/benchmark
rate used by ZW, was 6,50% and on 29 February 20.20 it decreased to 5,75%.

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QUESTION 1

YOU NOW HAVE 60 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks

PART I

Prepare the statement of changes in equity of Zwonke Wonke Ltd for the financial year 26
ended 29 February 20.20.

Please note:
• Comparatives figures are not required
• Ignore the total column
• Ignore taxation

Communication skills: presentation and layout 1

PART II

Discuss, with reasons, whether the fair value adjustment as a result of the loan acquired 12
from Charter Bank Ltd will be recognised in profit or loss and/or in other comprehensive
income in the statement of profit or loss and other comprehensive income of
Zwonke Wonke Ltd for the year ended 29 February 20.20.The subsequent measurement
of the fair value adjustment of the amounts recognised in profit or loss and/or in other
comprehensive income should also be addressed and explained.

Communication skills: presentation and layout 1

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QUESTION 1 – Suggested solution

PART I

Zwonke Wonke Ltd

Statement of changes in equity for the year ended 29 February 20.20

Share Capital Retained Mark to Allowance Totals

Earnings Market for credit
loss
a 1 4.2 a
Opening balance 35 000 000 11 541 727 3 633 34 600 46 579 960 (4)
2
Profit for the period 19 103 561 19 103 561 (4)

Equity instrument
Fair value adjustment
(1 000 000 x (2,85 - 2,50)) 350 000 350 000 (½)
Transfer to retained earnings
(350 000 x 20%) 70 000 (70 000) (2)

Fair value adjustment at year end

(1 000 000 x 80% x (3,30 – 2,85) 360 000 360 000 (1½)

Debentures
4.2
Fair value adjustment 25 799 25 799 (2½)
Derecognition
(3 633 + 25 799) x 3 000/12 000 7 358 (7 358) (3)

Credit loss (105 000 – 34 600) 70 400 70 400 (1)

Shares buyback
(1 000 000 x 15% x 35)
((40 – 35) x1 000 000 x 15%) (5 250 000) (750 000) (2½)
3
Dividends declared (1 060 000) (4)

29 750 000 28 912 646 662 074 105 000 59 429 720
Communication skills: presentation and layout (1)
a
Given

CALCULATIONS

C1. Adjusted retained earnings (opening balance)

Opening balance (given) 11 500 000 [½]
Fair value adjustment (error) (12 000) [½]
Transaction costs (error) 10 000 [½]
Effective interest (C4.1) 43 727 [½]
11 541 727

C2. Profit before tax

Given 19 500 000 [½]
Day 1 loss (2 500 000 – 1 000 000 x 3,5) (1 000 000) [1½]
Dividends received (1 000 000 x 80% x 0,70) 560 000 [1½]
Effective interest (C4.1) 43 561 [½]
19 103 561
C3. Dividends declared
(1 000 000 x 0,55 + 1 000 000 x 0,85 x 0,6) 1 060 000 [4]
1 060 000

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C4.1 Interest income on bonds

N = 5 [½]
PV = -430 000 (12 000 x 35 + 10 000) [1]
PMT = 45 360 (12 000 x 42 x 9%) [½]
FV = 420 000 (10 000 x 42) [½]
I = 10,17% per annum

Amortisation table for financial asset at amortised cost: bonds

Gross Effective Gross

carrying interest carrying
fixed at Interest
amount amount
Coupon
Opening 10,17% Closing
balance p.a. Balance
28 February 20.19 430 000 43 727 (45 360) 428 367
28 February 20.20 428 367 43 561 (45 360) 426 569

Alternative
20.19: 1 Amort interest = 43 727 [½]
20.20: 2 Amort interest = 43 561 [½]

C4.2 Fair value adjustment

20.19: 36 x 12 000 = 432 000 – (42 x 12 000 +10 000) + 43 727 – 45 360 = 428 367) = 3 633
[2½]
20.20: 38 x 12 000 = 456 000 – (432 000 + 43 561 – 45 360 = 430 201)) = -25 799 [2½]

PART II

The loan from Charter Bank was designated as a liability at fair value through profit and loss
(given) and it is stated that the separation of the loan’s credit component will not create or
enlarge an accounting mismatch. Therefore the change in fair value attributable to changes in
credit risk should be presented in other comprehensive income (IFRS 9.5.7.7(a)). (2)

ZW Ltd should therefore recognize a gain or loss on the fair value adjustment of the loan as
follows:

• The amount of the change in fair value that is attributable to changes in the credit risk
of the liability is recognised in other comprehensive income (IFRS 9.5.7.7 (a)); (1)
• The remaining amount of the change in fair value is recognised in profit or loss
(IFRS 9.5.7.7 (b)); (1)

The only significant change in market conditions for the liability is the change in the
observable benchmark interest rate (from 5,75% to 5,50%). The amount recognised in other
comprehensive income can be estimated as follows (IFRS 9.B5.7.18 (a)): (1)

First calculate the internal rate of return (IRR) at the start of the year by using the following
(IFRS 9.B5.7.18 (a)):

- Fair value of the liability at the start of the year; and (½)
- Remaining contractual cash flows of the liability. (½)

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PV = -2 million (½)
FV = 2,3 million (½)
PMT = 2 million x 9,5% = 190 000 (½)
N = 4 (½)
I = 12,61%

Then deduct the observable/benchmark interest rate at the start of the year from the IRR to
get the instrument specific component of the IRR. (1)

Instrument-specific component = 12,61% – 6,5% (benchmark at start of period) = 6,11%. (1)

,
Calculate the PV of the liability at the end of the year by using a discount rate equal to the (½)
sum of:

- The observable (benchmark) interest rate at the end of the year, and (½)
- The instrument specific component of the IRR from step 1 above. (½)

FV = 2 million (1)
PMT = 2 million x 9,5% = 190 000 (½)
I = 5,75% (benchmark at end of period) + 6.11% (instrument-specific
component) = 11.86%
n = 3
PV = -1 886 360

Subtract the amount as calculated above from the fair value of the liability as at the end of the
year. This amount R86 360 (R1 886 360 less R1 800 000) is not attributable to changes in the
repo interest rate and should therefore be recognised as a gain in other comprehensive
income. (1½)

The remaining fair value adjustment of R113 640 (R2 million – R1 886 360) will be recognised
in profit or loss as a loss. (1½)
Total (16)
Maximum (12)
Communication skills: logical argument (1)

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QUESTION 2 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

IGNORE ANY NORMAL INCOME TAX IMPLICATIONS.

IGNORE VALUE ADDED TAX

PART I 24 marks

Macko Ltd (Macko) is a retail store with a large presence throughout the Limpopo province in
South Africa. However, during the 20.18 financial year the company took a strategic decision to
expand to all the provinces in South Africa. The company is listed on the
Johannesburg Stock Exchange and has a 31 March year end.

In January 20.19 you were appointed as the financial manager and you are in the process of
finalizing the annual financial statements for the year ended 31 March 20.19.

The following balances, amongst others, appear in the trial balance of Macko for the year ended
31 March 20.19:
Notes Dr (Cr)
R
Financial asset at fair value through OCI: Bonds 1 1 550 000
Credit loss reserve 1 ?
Financial liability at amortised cost: Debentures 2 (15 000 000)

Notes

1. Financial asset at fair value through OCI: Bonds

On 1 April 20.17, Macko purchased bonds in XY Ltd at its fair value of R1,5 million.
Transaction costs incurred amounted to R10 000 and were paid in cash by Macko. The bonds
mature on 31 March 20.21 at a 5% premium and pay a coupon related rate of 8% per annum.

The shares are held within a business model with the objective to collect contractual cash
flows of principal and interest and to sell the shares.

The bonds were not credit-impaired at any stage. Macko estimated that the credit risk of the
bonds has not changed significantly from initial recognition and was still considered to be low.
The financial manager must still process the journal entry relating to the expected credit losses
in the current financial year.

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The following information is provided regarding the bonds:

12 months Lifetime Fair value

expected credit expected credit
losses losses
R R R
1 April 20.17 65 000 160 000 1 500 000
31 March 20.18 70 000 180 000 1 550 000
31 March 20.19 64 000 220 000 1 630 000

2. Financial liability at amortised cost

In order to expand its retail store to other provinces Macko decided to issue debentures to
raise the required funds. On 1 April 20.18, Macko issued debentures at fair value to a local
investor, Mlu Ltd, under the following terms and conditions:

Number of debentures 75 000

Maturity date 31 March 20.22
Nominal value of one debenture R200
Coupon interest rate 8% per annum on the nominal value
Market interest rate of similar debt instruments 8,5% per annum
having no conversion rights
Transactions costs paid by Macko on 1 April 20.18 R200 000

The debentures will be converted at the option of the debenture holders into the ratio of two
ordinary shares for each debenture held. Transactions cost was expensed to profit and loss.

Except for the entry in respect of the proceeds received on the issue of debenture, no other
entries were recorded in respect of these debentures. Macko did not elect to irrevocably
designate its financial liability to be measured at fair value through profit and loss in terms of
IFRS 9.4.2.2.

PART II 16 marks

Lanto Web Ltd (Lanto) is an internet company with a large presence throughout South Africa. The
company focuses on providing internet services to its client base which consists of consumers
across the economic value chain. Lanto is listed on the Johannesburg Stock Exchange and has a
31 December year end.

The following information of Lanto is availble for the year ended 31 December 20.18:

1. Trade receivables

Lanto ranked their customers according to the invididuals' livings standards, based on a
10-point scale with 10 being the highest living standard and 1 the lowest. Lanto has
segmented its customer population into two categories, namely those falling in 1-6 and those
in 7-10, for credit evaluation purposes.

Trade receivables results from transactions that is within the scope of IFRS 15 Revenue and is
payable within 30 days. Trade receivables only consist of the day to day trade receivables and
does not contain a significant finance component.

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The following default rates over the expected life of trade receivables have been historically
observed and are expected to continue:

Category 1-6 Category 7-10

12 month Lifetime 12 month Lifetime
expected expected expected expected
credit losses credit loss credit losses credit loss
Current 0,50% 1,00% 0,30% 0,50%
1-30 days past due 5,20% 8,10% 3,30% 6,20%
More than 30 days past due 16,10% 26,00% 10,00% 15,70%

The following financial data were extracted from the accounting records with regard to the
gross carrying amount of all trade receivables as at 31 December 20.18:

R
Current 67 000 000
1-30 days past due 14 991 250
More than 30 days past due 1 758 750
Total 83 750 000

Lanto estimates that 20% of its trade receivable come from category 1-6 and 80% from
category 7-10. These are proportionately spread across the ageing categories above.

2. Options

Lanto acquired an option to purchase 185 000 ordinary shares of Netco Ltd (Netco) at R6,80
per share, when Netco's shares were trading at the price of R6,80. Latco consider the ordinary
shares of Netco to be a viable investment for speculative purposes. Lanto paid R62 900 for the
option on 25 August 20.18 and also had to pay a commission of 2% of the purchase price of
the option to brokers. The option will expire on 10 February 20.19. On 31 December 20.18 the
option was worth R104 400, at which date Netco's shares traded at R8,02 each.

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QUESTION 2

YOU NOW HAVE 60 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks

PART I

Prepare the journal entries, which should still be processed, in respect of the items listed in 23
the extract of the trial balance of Macko Ltd for the year ended 31 March 20.19. Your
journal should not reverse any journals already processed. If necessary, correcting
journals should be provided.

Please note
• Journal narrations are not required.
• Journals should be dated.

Communication skills: presentation and layout 1

PART II

(a) Calculate the amount and discuss the measurement of the loss allowance that 8
should have been recognised on trade receivables in the financial statements of
Lanto Web Ltd as at 31 December 20.18 in terms of IFRS 9 Financial Instruments.

Communication skills: clarity of expression 1

(b) Discuss the correct classification, recognition and measurement of the option to 6
acquire ordinary shares in Netco Ltd, in the financial statements of Lanto Web Ltd
for the financial reporting period ended 31 December 20.18 in terms of IFRS 9
Financial Instruments.

Communication skills: clarity of expression 1

Please note:

• Round off all amounts to the nearest rand.

• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 2 – Suggested solution

PART I

(a) Journal entries

Dr Cr
R R

Financial asset at fair value through OCI

(Note 1)

31 March 20.19
J1 Bank (SFP) (1 500 000 x 8%) 120 000 (1½)
Financial assets at fair value through OCI (SFP) 16 502 (1)
Interest income (P/L) [C1] 135 502 (3)
J2 Financial asset at fair value through OCI (SFP) [C2] 63 498 (2)
Fair value gain (OCI) 63 498 (1)
J3 Expected credit loss reserve (OCI) 6 000 (½)
Expected credit loss (P/L) (70 000 – 64 000) 6 000 (1½)

Debenture (Note 2)

1 April 20.18
J4 Financial liability at amortised cost: Debentures (SFP) 245 670 (3½)
Equity component of convertible debentures
(SCE) [C3.2] 245 670 (½)
J5 Equity component of convertible debentures (SCE) 3 276 (1)
Financial liability at amortised cost: Debenture (SFP)
[C3.3] 196 724 (2)
Transaction costs (P/L) 200 000 (1)
31 March 20.19
J6 Interest expense (P/L) [C3.4] 1 296 868 (2½)
Bank (SFP) 1 200 000 (1)
Financial liability at amortised cost: Debentures
(SFP) 96 868 (1)
Total (23)
Communication skills: presentation and layout (1)

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CALCULATIONS

C1. Effective interest rate of bonds

FV = 1 575 000 [½]

N = 4 [½]
PMT = 120 000 [½]
PV = -1 510 000 (1 500 000 + 10 000) [½]
I = 8,89% [½]
Interest for 2019: 2 AMORT (INT) 135 502
[2½]

C2. Fair value adjustment:

Balance for 20.19 (1 550 000 + 16 502 (135 502 [C1] – 120 000)) 1 566 502 [1]
Fair value given (1 630 000) [½]
63 498
[1½]

C3.1 Liability component

N = 4 [½]
FV = 15 000 000 (75 000 x R200) [½]
PMT = 1 200 000 (15 000 000 x 8%) [½]
I = 8,5% [½]
PV = ? 14 754 330
[2]

C3.2 Equity component

Proceeds at issue 15 000 000 [½]

Liability component 14 754 330 [½]
245 670
[1]

C3.3 Transaction costs

Liability component: 200 000 x 14 754 330/15 000 000 = 196 724 [1½]
Equity component: 200 000 – 196 724 = 3 276 [½]
[2]

C3.4 Effective interest rate

PV after transactions cost = (14 557 606) (14 754 330 – 196 724) [½]
N = 4 [½]
FV = 15 000 000 [½]
PMT = 1 200 000 [½]
I = ? 8,91
Interest expense 1 INPUT AMORT = 1 296 868
[2]

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PART II

(a) Calculate and discuss the amount of the loss allowance that should have been
recognised on trade receivables in the financial statements of Lanto Web Ltd as
at 31 December 20.18 in terms IFRS 9 Financial instruments.

Since Lanto’s trade receivables results from transactions that are within the scope of
IFRS 15 and do not contain a significant financing component, the allowance for credit
losses recognised and measured is the amount equal to lifetime expected credit losses
(simpified approach) (IFRS 9.5.5.15). (2)

The expected credit loss allowance should be measured using the default rates over the
expected life of Lanto’s trade receivable to stratify the population of contract by risk
characteristics (debtors age analysis) (IFRS 9.5.5.17(c)). (1)

Reasonable and supportable information is available in the form of historical default rates
over the expected life of trade receivables and contract assets in a provision matrix
(IFRS 9.5.5.17(c)). (1)

The rebuttable presumption that assets that are more than 30 days past due reflects a
significant increase in credit risk, is not relevant in this case, since the simplified approach
election means that Lanto in any case recognise lifetime expected credit losses on all its
contract assets, regardless of whether a significant increase in credit risk has occurred or not
(IFRS 9.5.5.11). (1)

The amount of loss allowance recognised:

67 000 000 x 20% x 1,00% 134 000 (1)
67 000 000 x 80% x 0,50% 268 000 (1)
14 991 250 x 20% x 8,10% 242 858 (1)
14 991 250 x 80% x 6,20% 743 566 (1)
1 758 750 x 20% x 26,00% 91 455 (1)
1 758 750 x 80% x 15,70% 220 899 (1)
Total 1 700 778
Total (11)
Maximum (8)
Communication skills: clarity of expression (1)

(b) Discuss the correct classification, recognition and measurement of the option to
aquire ordinary shares in Netco Ltd, in the separate financial statements of
Lanto Web Ltd for the financial reporting period ended 31 December 20.18 in
terms IFRS 9 Financial instruments.

Lanto's business model for the option (derivative) is not to hold to collect contractual cash
flows and can therefore not be classified as financial assets subsequently measured at
amortised cost or fair value through other comprehensive income (IFRS 9.4.1.2). (1)

Consequently the option will be classified as subsequently measured at fair value through
profit or loss (IFRS 9.4.1.4). (1)

Lanto shall recognised the option as a financial asset only when Lanto becomes a party to
the contractual provision of the option (IFRS 9.3.1.1). Lanto acquired the option on
25 August 2018 and therefor became a party to the contract on that date. (1)

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Lanto will initially recognise the option at it’s fair value amount (amount paid) of R62 900
(IFRS 9.5.1.1). (1)

The transaction costs (commission R62 900 at 2%) should not be included in the initial
measurement of the option as it is classified at fair value through profit or loss (1)
(IFRS 9.5.1.1).

Lanto shall subsequently measure the option at its fair value of R104 400 on
31 December 20.18. The fair value gain (R41 500) is recognised in profit or loss (1)
(IFRS 9.5.2.1).

Subsequent changes in the fair value of the option cannot be presented in other
comprehensive income as it is held for trading (IFRS 9.5.7.5). A derivative (option) meets the
definition of 'held for trading' (IFRS 9, Appendix A) (2)
Total (8)
Maximum (6)
Communication skills: clarity of expression (1)

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QUESTION 3 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

PART I 28 marks

IGNORE ANY NORMAL INCOME TAX IMPLICATIONS

Stein Oops Ltd (Stein Oops), a South African company situated in Stellenbosch, is a fashion house
and luxury retail company founded in 20.10. Stein Oops is listed on the Johannesburg Stock
Exchange and has a 31 December year end.

Stein Oops has experienced tremendous success in the industry, and as a result in October 20.16,
the board of directors decided to expand operations to Botswana and Namibia.

In order to improve its financial position for the anticipated expansion in operations, Stein Oops
decided to make some changes to their financial instruments portfolio.

The following transactions still need to be accounted for in the accounting records of Stein Oops for
the year ended 31 December 20.17.

1. Long-term loan

Stein Oops had borrowed R4 800 000 cash from Stimela Bank Ltd on 1 January 20.15. The
loan and interest are payable over five years on 31 December each year, at an effective
interest rate of 9,87%.

On 1 January 20.17, Stein Oops renegotiated the terms of the loan payable with
Stimela Bank Ltd. An agreement was reached whereby Stein Oops would pay
Stimela Bank Ltd R3 195 000 as full and final settlement of the loan payable.

Stein Oops did not elect to irrevocably designate its financial liabilities in terms of IFRS 9.4.2.2
to be measured at fair value through profit or loss.

2. Listed bonds

Stein Oops acquired 10 000 listed bonds issued by Zera Ltd on 1 January 20.17 at the nominal
value of R500 per bond. Transaction costs amounted to R12 000 and were paid by Zera Ltd.
The coupon interest on the bonds is 11% per annum, receivable on 31 December. The bonds
were acquired as a means to access steady contractual cash flows on an annual basis and
when the opportunity arises, Stein Oops will sell the bonds to re-invest in other financial assets
with a higher return. If the bonds are not sold, they will be redeemed within 5 years, at which
time the nominal value will be paid to Stein Oops.

The fair value of the bonds were as follows:

Date R / bond
1 January 20.17 R504
31 December 20.17 R457

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The credit risk on the bonds was adequately assessed on initial recognition and was
considered as low risk. On 31 December 20.17 Stein Oops determined that the credit risk of
the bonds had increased significantly since initial recognition, but there was no objective
evidence that they are credit impaired.

Stein Oops did not elect to irrevocably designate its financial assets to be measured at fair
value through profit or loss in terms of IFRS 9.4.1.5.

The 12-month expected credit loss as well as the lifetime expected credit losses on the bonds
were as follows:

Date 12-month Lifetime

expected expected
credit losses credit losses
R R
1 January 20.17 7 500 21 200
31 December 20.17 9 200 28 300

3. Equity investment

On 30 June 20.17, Stein Oops sold its equity investment in Elle Rines Ltd at its fair value of
R2 390 000 and also incurred selling costs of R32 400. The equity investment was purchased
on 1 May 20.16 at R2 182 100 including transaction costs of R29 170. This investment was
designated and measured at fair value through other comprehensive income in terms of
IFRS 9.4.1.4. The fair value of the equity investment on 31 December 20.16 was R2 286 200.

Stein Oops transfers cumulative fair value gains or losses to retained earnings upon the sale of
investments that were designated as financial assets at fair value through other
comprehensive income.

Additional information

1. The directors of Stein Oops decided to early adopt IFRS 9 Financial Instruments with effect
from 1 January 20.15.

2. The retained earnings of Stein Oops for the year ended 31 December 20.16 was R43 223 110.

3. Stein Oops declared an ordinary dividend of R3 830 000 on 31 August 20.17.

4. The profit for the year of Stein Oops (before taking into account the above transactions) was
R18 734 210 for the year ended 31 December 20.17.

PART II 12 marks

Airplane Financing Ltd (Airplane Financing), is a South African company based in Cape Town which
specialises in the financing and sale of airplanes. The company was launched in 20.1 and has a
28 February financial year end.

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You are the newly appointed financial accountant at Airplane Financing. The Chief Executive Officer
(CEO), is aware that you have just passed your CTA and have an excellent understanding of all the
new accounting standards.

The financial manager is not up to date with his knowledge regarding IAS 32 Financial Statements:
Presentation and IFRS 9 Financial Instruments.

The CEO has asked you to assist the financial manager with the following two matters:

1. Loan to Best Airlines Ltd

During November 20.17, Best Airlines Ltd (Best Airlines), a passenger carrier that operates
locally in South Africa, approached Airplane Financing for a loan to purchase a new airplane.

The negotiations for the loan was successful and Airplane Financing agreed to provide
Best Airlines with a loan of R25 million to purchase an airplane.

A contract was successfully signed by Best Airlines and Airplane Financing on

1 February 20.18 with the following terms:

• The principal amount of the loan will be used to purchase the new airplane from
Airplane Financing.
• The principal amount must be paid back in five equal instalments with the first instalment
due on 31 January 20.19.
• The interest rate was agreed at 9% which is regarded as a market related interest rate
and is payable annually on 31 January.
• Legal title of the airplane has been ceded as security until such time that the loan is fully
repaid.

Airplane Financing allocated the loan in the same portfolio as all its other airplane financing
loans. This portfolio is held to collect contractual cash flows only and the income is used to
fund the operations of Airplane Financing’s own business.

2. Extract of notes to the financial statements

The CEO has provided you with the following extract of the notes to the financial statements of
Airplane Financing for the year ended 28 February 20.18.

Extract of the notes for the year ended 28 February 20.18

1. Accounting policies

1.1 Trade receivables

Trade receivables only consist of the day to day trade receivables and does not contain a
significant financing component.

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1.2 Allowance for credit losses relating to trade receivables

The allowance for credit losses is assessed each year based on the following:

• If the credit risk has not increased significantly, 12 month expected credit losses
are used.
• If the credit risk increased significantly, the loss allowance will be equal to the
lifetime expected credit losses.
• Interest is calculated using the effective interest rate method.

4. Trade and other receivables

R
Trade receivables 400 000
Less: Allowance for credit losses 20 000
Net trade receivables 380 000

Additional information

Assume Airplane Financing elected early adoption of IFRS 9 Financial Instruments.

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QUESTION 3

YOU NOW HAVE 60 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks

PART I

(a) Provide the journal entries to account for transactions 1 and 2 in the accounting 10
records of Stein Oops Ltd on 1 January 20.17.

Communication skills: Presentation and layout 1

(b) Provide the journal entries to account for the equity investment in the accounting 8
records of Stein Oops Ltd from 1 May 20.16 to 30 June 20.17.

Please note:
• Journal narrations are not required.
• Your journals should be dated.

(c) Taking all matters referred to in the question into account, prepare only the “retained 8
earnings” column in the statement of changes in equity of Stein Oops Ltd for the
financial year ended 31 December 20.17. The statement of changes in equity
should commence with the opening balances at 1 January 20.17. The total column is
not required.

Communication skills: Presentation and layout 1

PART II

(a) Write a memorandum to the financial manager of Airplane Financing Ltd in which 7
you discuss:

(i) in terms of the definitions of IAS 32 Financial Statements: Presentation, the

correct classification of the loan to Best Airlines Ltd.
(ii) the initial recognition and classification of the loan to Best Airline Ltd in terms
of IFRS 9 Financial instruments.

Communication skills: Format 1

(b) Discuss your concerns regarding the extract of the trade and other receivables note 4
disclosure in terms of IFRS 7 Financial Instruments: Disclosure and IFRS 9
Financial Instruments.

Please note:

• Ignore all normal income tax implications.

• Calculations are not required.
• Round off all amounts to the nearest Rand.
• Comparative figures are not required.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 3 – Suggested solution

PART I

(a) Journal entries

Dr Cr
R R
1 January 20.17
J1 Financial liability at amortised cost: loan payable (SFP)
(C1) 3 145 667 (3)
Loss on de-recognition of loan payable (P/L) 49 333 (1)
Bank (SFP) 3 195 000 (1)
De-recognition of loan payable
J2 Financial asset measured at fair value through OCI: bonds
(SFP) (10 000 x R504) 5 040 000 (1½)
Day one gain on acquisition of bonds (P/L) 40 000 (1)
Bank (SFP) (10 000 X R500) 5 000 000 (1)
Initial recognition of investment in bonds at fair value
J4 Expected credit losses (P/L) 7 500 (1)
Expected credit loss reserve (OCI) 7 500 (½)
Recognition of 12-month expected credit losses
Total (10)
Communication skills: Presentation and layout (1)

CALCULATIONS

C1. Amortised cost of the loan payable on 1 January 20.17

N = 5 [½]
I = 9.87% [½]
FV = 0 [½]
PV = 4 800 000 [½]
PMT = 1 262 025
[2]
2 (period 2) Amort [balance] = 3 145 667 [½]

(b) Journal entries equity investments

Dr Cr
R R
1 May 20.16
Financial asset at fair value through OCI: shares
J1 (SFP) 2 182 100 (1)
Bank (SFP) 2 182 100 (½)
31 December 2016
Financial asset at fair value through OCI: shares
J2 (SFP) 104 100 (1)
Mark-to-market reserve (OCI)
(2 286 200 – 2 182 100) 104 100 (½)
30 June 2017
Financial asset at fair value through OCI: shares
J3 (SFP) 103 800 (1)
Mark-to-market reserve (OCI) 103 800 (½)

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Dr Cr
R R
J4 Selling costs (P/L) 32 400 (½)
Bank (SFP) 32 400 (½)
J5 Bank (SFP) 2 390 000 (½)
Financial asset at fair value through OCI: shares
(SFP) 2 390 000 (½)
J6 Mark-to-market reserve (SCE) 207 900 (½)
Retained earnings (SCE) 207 900 (1)
(104 100 + 103 800)
(8)

(c) STEIN OOPS LIMITED

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 20.17

Retained
earnings
R

Balance at 1 January 20.17 43 223 110 (½)

Total comprehensive income for the year:
a
- Profit for the year 19 240 727 (6)
Transfer from mark-to-market reserve 207 900 (1)
Ordinary dividend (3 830 000) (1)
Balance at 31 December 2017 58 621 237
Total (8½)
Maximum (8)
Communication skills: Presentation and layout (1)
a
18 734 210[½] – 49 333[½](from (a)) + 40 000[½](from (a)) – 7 500[½](from (a)) – 20 800
(28 300 – 7 500)[1] + 543 550b[2½] – 32 400[½] (from (b)) = 19 207 727
b
Interest income

N = 5 [½]
PMT = 500 x 10 000 x 11% = 550 000 [½]
FV = 5 000 000 [½]
PV = 504 x 10 000 = 5 040 000 [½]
I = 10,785%
[2]

1 Amort [INT] = 543 550 [½]

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PART II

(a) Definition, initial recognition and classification of financial asset

To: Financial Manager

From: Financial Accountant
Date: 8/02/20.18
Subject: Accounting treatment of financial asset

Good day

Please see below discussion regarding the initial recognition and classification of the loan to
Best Airlines Ltd in terms of IAS 32 and IFRS 9.

(i) Definition

• In terms of IAS 32.11, a financial asset is any asset that is:

(a) cash
(b) an equity instrument of another entity
(c) A contractual right
(i) to receive cash or another financial asset from another entity; or
(ii) to exchange financial assets or liabilities with another entity
under conditions that are potentially favourable to the entity.

• There is a contractual right as there is a signed contract between

Best Airlines and Airplane Financing on 1 February 20.18. (1)

• Airplane Financing has a contractual right to receive cash from

Best Airlines in the form of an amount interest payment and a payment of
the principal amount over the next five years. (1)

• Thus, the loan can be recognised as a financial asset in the accounting

records of Airplane Financing Ltd. (1)

(ii) Initial recognition

• An entity shall recognise a financial asset or a financial liability in its

statement of financial position only when it becomes party to the
contractual provisions of the instrument (IFRS 9.3.1.1).

• The contract was signed on the 1 February 20.18 - Airplane Financing

only became party to the contract on that date and thus the loan must be
recognised in the accounting records of Airplane Financing on
1 February 20.18. (1)

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Classification of financial asset:

• A financial asset shall be measured at amortised cost if both the following

conditions are met: (IFRS9.4.1.2):
(a) the financial asset is held within a business model whose objective
is to hold financial assets in order to collect contractual cash-flows.
(b) The contractual terms of the financial assets give rise on specified
dates to cash flows that are solely payments of principle and interest
on the principal amount outstanding.

• Airplane Financing holds the loan in their portfolio to collect contractual

cash flows only – thus the financial asset is held within a business model
whose objective it is to hold financial assets to collect contractual
cashflows. (1)

• The contractual terms of the loan specifies that the interest is payable on
specific dates, namely on an annual basis on 31 January and the principal
amount is payable in 5 equal amounts on 31 January. (1)

• Therefore the cash flows receivable by Airplane Financing Ltd on

specified dates are solely payments of principal and interest on the
principal amount outstanding. (1)

• The loan thus meets both conditions and is classified as a financial asset
measured at amortised cost. (1)

I trust that you will find the above in order.

Kind regards
Financial Accountant
Total (8)
Maximum (7)
Communication skills: Logical flow and conclusion (1)

(b) Concerns regarding the extract on trade and other receivables note disclosure

Trade receivables and allowance for credit losses

• An entity shall always measure the loss allowance at an amount equal to

lifetime expected credit losses for trade receivables or contract assets that’s
result from transactions that are within the scope of IFRS 15 and that do not
contain a significant financing component in accordance with IFRS 15
(IFRS 9.5.5.15 (a)(i)).

• As the trade receivables do not contain a significant financing component, the

allowance for credit losses is the amount equal to lifetime expected credit losses
(simplified approach) and therefore the policy note should be corrected and
exclude the 12 month credit losses component. (1)

• The policy should not refer to interest calculations as there is no significant

financing component included in the trade receivables. (1)

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• In order to explain the changes in the loss allowance and the reasons for those
changes, Airplane Financing Ltd must provide, by class of financial instrument,
a reconciliation from the opening balance to the closing balance of the loss
allowance, in a table, showing separately the changes during the period for the
loss allowance measured at an amount equal to lifetime expected credit losses
for trade receivables, contract assets or lease receivables for which the loss
allowance is measured in accordance with paragraph 5.1.15 of IFRS 9
(IFRS 7.35H).

• Airplane Financing Ltd has not provided a reconciliation of the lifetime expected
credit losses from the opening to the closing balances. (1)

• In terms of IFRS 7.35G, an entity shall explain the inputs, assumptions and
estimation techniques used to recognise the expected credit losses. For this
purpose an entity shall disclose:
(a) the basis of inputs and assumptions and the estimation techniques used
to:
(i) measure the lifetime expected credit losses;
(ii) determine whether a financial asset is a credit impaired financial (½)
asset.
(b) how forward looking information has been incorporated into the
determination of expected credit loses, including the use of (½)
macroeconomics information; and
(c) Changes in the estimation techniques or significant assumptions made (½)
during the reporting period and he reasons for those changes.
• Airplane Financing did not disclose:
(a) any basis of input, assumptions and estimation, (½)
(b) any forward looking information that has been incorporated into the
determination of the expected credit losses; or (½)
(c) any changes in the estimation technique or significant assumptions and
the reasons for those changes. (½)
Total (6)
Maximum (4)

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QUESTION 4 20 marks

YOU HAVE 8 MINUTES TO READ THIS QUESTION

Strawberry Ltd (Strawberry) is a South African company situated in Stellenbosh and the largest
organic strawberry farm in South Africa. Strawberry is listed on the JSE Limited and has a
31 December year end.

During 20.14 there was an increased demand for strawberries due to the numerous published
scientific studies demonstrating the health benefits of strawberries. Strawberry had to expand its
operations to meet this increased demand for organic strawberries.

1. Expansion project

In order to expand its operations Strawberry had to expand its strawberry storage facilities in
Stellenbosch. Strawberry decided to issue debentures to raise the required funds for this
expansion project. On 1 January 20.15, Strawberry issued debentures at fair value to a local
investor, Kapitek Ltd, under the following terms and conditions:

Number of debentures 100 000

Maturity date 31 December 20.17
Redemption value Redemption at a 5% premium on the nominal value
Nominal value of one debenture R180
Coupon interest rate 9% per annum on the nominal value
Market interest rate of similar 8,5% per annum
instruments

Strawberry did not elect to irrevocably designate its financial liabilities in terms of
IFRS 9.4.2.2 to be measured at fair value through profit or loss.

2. Investment in listed bonds

On 1 January 20.15 Strawberry purchased an investment in listed bonds at fair value.

Strawberry correctly classified the listed bonds as a financial asset measured at amortised cost
in terms of IFRS 9 Financial Instruments. These bonds mature on 31 December 20.17 when
the principal amount of R980 000 will be received. The coupon rate on the bonds is 8% per
annum on the nominal value, payable annually on 31 December. The market-related interest
rate for similar listed bonds on 1 January 20.15 was 9% per annum.

The directors of Strawberry decided on 15 November 20.15 to change the business model for
managing its investments in listed bonds. In future, Strawberry’s business model for managing
its investments in listed bonds will have the objective of collecting contractual cash flows and
selling the listed bonds. Therefore, both collecting contractual cash flows and selling the bonds
will be integral to achieving the business model’s objective of Strawberry.

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Strawberry assessed the credit risk of the bonds and determined that these bonds have a low
credit risk. The financial manager of Strawberry, provided you with the following schedule of
the assessed credit risk and estimated expected credit losses of its investment in the bonds of
Kapitek:

Date Assessed credit risk 12-month Lifetime

expected credit expected credit
losses losses
R R

31 December 20.15 Low credit risk 15 600 44 600

31 December 20.16 Low credit risk 18 200 52 400

The fair value of the investment in bonds on the respective dates were as follows:

Fair value
Date R

15 November 20.15 968 000

1 January 20.16 970 000
31 December 20.16 995 000

Additional information

Strawberry early adopted IFRS 9 Financial Instruments on 1 January 20.15.

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QUESTION 4

YOU NOW HAVE 30 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks
(a) Discuss the classification and measurement of the debentures (transaction 1) in the 6
financial statements of Strawberry Ltd for the year ended 31 December 20.16 in
terms of IAS 32 Financial Instruments: Presentation and IFRS 9 Financial
Instruments. Your discussion should include calculations.

Communication skills: logical argument 1

(b) Provide the journal entries to account for the investment in bonds (transaction 2) in 13
the financial statements of Strawberry Ltd for the year ended 31 December 20.16.

Please note:
• Journal narrations are not required.
• Your journals should be dated.

Please note:

• Ignore any normal income tax implications.

• Round off all amounts to the nearest Rand.
• Your answer must comply with International Financial Reporting Standards (IFRS).

MJM
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QUESTION 4 – Suggested solution

PART A

(a) Classification and measurement of the debentures in the financial statements of

Strawberry Ltd

Classification
• Strawberry has a contractual obligation to deliver cash to Kapitek Ltd in the form of
annual coupon payments and the redemption amount (IAS 32.11(a)(i)). (1)
• Hence the debentures issued are classified in the financial statements of
Strawberry Ltd as a financial liability in terms of IAS 32. (½)

Measurement
• The debentures issued by Strawberry should be measured at a fair value of
R18 934 479 [C1] on initial recognition. (2½)
• The impact of transaction costs on the initial measurement may be ignored by
Strawberry since the transaction costs were paid by the investor (Kapitek Ltd). (1)
• All financial liabilities are subsequently measured at amortised cost except for those
financial liabilities mentioned in IFRS 9.4.2.1(a) – (e). (½)
• Since the debentures issued are not those financial liabilities mentioned in
IFRS 9.4.2.1(a)–(e) the debentures should be subsequently measured at amortised (½)
cost.
• The effective interest rate on the debentures is the market interest rate on similar
instrument of 8,5% per annum. (1)
• The amortised cost of the debentures on 31 December 20.16 amounts to
R18 912 442 [C2]. (1)
Total (8)
Maximum (6)
Communication skills: logical argument (1)

CALCULATIONS

C1. Present value of the bonds issued on 1 January 20.15

N = 3 [½]
I = 8,50 [½]
FV = 100 000 x R180 x 1,05 = 18 900 000 [½]
PMT = 100 000 x R180 x 9% = 1 620 000 [½]
PV = 18 934 479
[2]

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C2. Amortised cost of the bonds issued on 31 December 20.16

2 Amort = 18 912 442 [½]

(b) Journal entries

Dr Cr
R R
1 January 20.16
J1 Financial asset measured at fair value through OCI (SFP) 970 000 (1)
Financial asset at amortised cost (SFP) [C3] 962 761 (2½)
Fair value gain (OCI) (970 000 - 962 761 [C3]) 7 239 (1)
Allowance for expected credit losses (SFP) (given) 15 600 (1)
Expected credit loss reserve (OCI) 15 600 (½)

31 December 20.16
J2 Financial asset measured at fair value through OCI (SFP) 8 249 (½)
Interest income (P/L) [1 Amort or 962 761 x 9%] 86 649 (1)
Bank (SFP) (980 000 X 8%) 78 400 (1)

J3 Financial asset measured at fair value through OCI (SFP)

(970 000 [J1] + 8 249 [J2] – 995 000 (given)) 16 751 (2)
Fair value gain (OCI) 16 751 (½)

J4 Expected credit losses (P/L) (18 200 – 15 600) 2 600 (1½)

Expected credit loss reserve (OCI) 2 600 (½)
(13)

CALCULATIONS

C3. Present value on 1 January 20.16 before reclassification

N = 2 [½]
I = 9 [½]
FV = 980 000 [½]
PMT = 980 000 x 8% = 78 400 [½]
PV = 962 761
[2]

COMMENT

• Please note that reclassification is at an awereness level.

• The change in the business model will result in a reclassification.
• The reclassification will only be effected on reclassification date (i.e.) the first day of
the reporting period after the change in the business model occurred (in this case,
1 January 20.16).

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QUESTION 5 18 marks

YOU HAVE 7 MINUTES TO READ THIS QUESTION

Tsogamo Ltd (Tsogamo) has investments and operations in the South African gaming and food
industry and is listed on the JSE Limited. Since its establishment in 19.97, the company has
positioned itself as a formidable player in the industry. The following transactions occurred during the
financial year ended 31 December 20.15.

Tsogamo signed an agreement with Fuelup Holdings Ltd to open up Big Burger franchise
restaurants at their service garage outlets. This will expand the existing 30 Big Burger franchise
restaurants currently operating in South Africa. The South African fast food market has grown rapidly
increasing the demand for hamburgers. The expansion will result in 20 Big Burger franchise
restaurants being opened in 20.15 and a further 80 restaurants in 20.16 and 20.17. Tsogamo funded
the R30 million Big Burger franchise restaurants expansion as follows:

1. Sale of investment in shares

On 30 June 20.15, Tsogamo sold its equity investment in More Gaming Holdings Ltd at a fair value
of R9 500 000. The investment was acquired on 1 April 20.14 by Tsogamo as a 5% equity
investment in More Gaming Holdings Ltd for R8 622 500 including transaction costs of R122 500.
The investment was held as a long-term strategic investment since More Gaming Holdings Ltd
develops gambling products and is a significant player in the South African gaming industry. The
investment was designated and measured at fair value through other comprehensive income in
terms of IFRS 9.5.7.5. The fair value on 31 December 20.14 was R8 800 000.

It is the policy of Tsogamo Ltd to transfer cumulative fair value gains or losses presented in the
market-to-market reserve to retained earnings upon the sale of the equity investment.

2. Issue of convertible debentures

Tsogamo issued 10 000 9% convertible debentures on 1 March 20.15 to National Bank. The
convertible debentures have a four year term and were issued at a face value of R1 000 each.
Interest is payable annually in arrears. Each debenture is convertible at the option of National Bank
at any date up to maturity into 50 ordinary shares. If not converted, the debentures will be settled in
cash at face value at maturity date. The financial instruments have been correctly classified as a
compound instrument.

On 1 March 20.15 the prevailing market related interest rate for debentures without conversion rights
was 12%. The allocation of the proceeds of the debentures on 1 March 20.15 was correctly done in
terms of IAS 32 Financial instruments: Presentation:
R
a
Liability component 9 088 795
Equity component 911 205
Total proceeds 10 000 000

a
N = 4 years
I = 12% per year
PMT = R900 000 (R10 000 000 x 9%)
FV = R10 000 000
PV = R9 088 795

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The interest expense relating to the convertible debentures was correctly accounted for in the
accounting records of Tsogamo.

3. Cash reserves

Existing cash reserves of R10 500 000 were used for the expansion project.

Additional information

1. Tsogamo selected to early adopt IFRS 9 Financial Instruments.

2. The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%.

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QUESTION 5

YOU NOW HAVE 30 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks
(a) Provide the journal entries to record the transactions in respect of the investment in 9
More Gaming Holdings Ltd from the date of acquisition to the date of disposal in the
accounting records of Tsogamo Ltd.

Please note:
• Ignore journal narrations.
• Ignore normal income tax implications.
• Indicate the date of the journal entry.

(b) Assume Tsogamo Ltd incurred R50 000 transaction costs to issue the convertible 8
debentures. Discuss the accounting treatment of the transactions costs and the
effect thereof on the convertible debentures at initial recognition.

Please note:
• Ignore any normal income tax implications.
• Support you answer with calculations.

Communication skills: logical argument 1

Please note:

• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 5 - Suggested solution

(a) Journal entries equity investments

1 April 20.14
J1 Financial asset at fair value through OCI (SFP) 8 622 500 (½)
Bank (SFP) (8 500 000 + 122 500) 8 622 500 (1½)
31 December 20.14
J2 Financial asset at fair value through OCI (SFP) 177 500 (1½)
Mark-to-market reserve (OCI)
(8 800 000 – 8 622 500) 177 500 (½)
30 June 20.15
Financial asset at fair value through OCI ( SFP)
J3 (9 500 000 – 8 800 000) 700 000 (1½)
Mark-to-market reserve (OCI) 700 000 (½)
J4 Bank (SFP) (given) 9 500 000 (1)
Financial asset at fair value through OCI (SFP) 9 500 000 (½)
J5 Mark-to-market reserve (SCE) (177 500 + 700 000) 877 500 (1)
Retained earnings (SCE) 877 500 (½)
Total (9)

(b) Transaction costs

The convertible debentures are classified as a compound instrument. (1)

IFRS 9.5.1.1 allows for the capitalisation of transaction costs for financial assets not
subsequently measured at fair value through profit or loss.

The financial liability component will be subsequently measured at amortised cost

(IFRS 9.4.2.1) and there is no subsequent measurement for the equity component. (1)

The transaction costs of R50 000 should be capilatised as the compound instrument is not
subsequently measured at fair value through profit or loss. (1)

The transaction costs should be allocated to the financial liability and equity components of the
compound instrument in proportion to the allocation of the proceeds. (1)

An amount of R45 444 (50 000x (9 088 795/10 000 000) will be allocated to the financial
liability component and R4 556 (50 000 – 45 444) to the equity component. (2)

Since the R45 444 is debited to the financial liability a new effective interest rate should be
calculated. The new effective interest rate is 12.16% (PV =-9 043 351 (9 088 795 – 45 444)
N=4; PMT 900 000 FV= 10 000 000). (2)

The R4 556 allocated to the equity component will be debited directly to equity. (1)
Total (9)
Maximum (8)
Communication skills: logical argument (1)

MJM
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QUESTION 6 38 marks

YOU HAVE 14 MINUTES TO READ THIS QUESTION

Ukhozi Transport Ltd (Ukhozi) is a listed company with a 30 June year end. The financial manager of
Ukhozi is busy finalising the accounting records for the year ended 30 June 20.15. You have been
approached by the financial manager for advice on the following outstanding matters:

Matter 1

On 1 July 20.14 Ukhozi made an investment in listed bonds at fair value and classified it as
measured at amortised cost in terms of IFRS 9.4.1.2. The directors of Ukhozi decided on
30 April 20.15 to change the business model for managing its investments in listed bonds. In future,
Ukhozi’s business model for investments in listed bonds will have the objective of both collecting
contractual cash flows and selling the listed bonds. In other words, both collecting contractual cash
flows and selling the debentures are integral to achieving the business model’s objective. The fair
value of the investment in listed bonds is R1 030 000 on 30 April 20.15 and R1 050 000 on
1 July 20.15. The following is an extract of the general ledger of Ukhozi for the year ended
30 June 20.15:

Financial asset at amortised cost: listed bonds (SFP)

1 July 20.14 Bank R1 000 000 30 June 20.15 Bank# R100 000
30 June 20.15 Interest income R 120 000

#
Coupon interest of R100 000 is receivable per annum until maturity.

Allowance for expected credit losses: listed bonds (SFP)

1 July 20.14 Expected credit loss R2 150
30 June 20.15 Expected credit loss R 350

Matter 2

On 1 January 20.14 Ukhozi acquired 1 000 R100 12% per annum unlisted bonds at the fair value of
R97 000. Transaction costs of R1 500 were incurred and paid on the same date by Ukhozi. The
bonds pay interest annually on 31 December and the capital will be settled at maturity on
31 December 20.16. Ukhozi classifies unlisted bonds as financial assets measured at amortised
cost. On initial recognition of the bonds the 12-month expected credit losses was estimated at
R1 500 and the lifetime expected credit losses at R21 500. On 30 June 20.14 it was determined that
the credit risk did not increase significantly and the 12-month expected credit losses were estimated
at R1 800 and the lifetime expected credit losses at R22 800. On 30 June 20.15 Ukhozi determined
that the credit risk of the unlisted bonds increased significantly since initial recognition, but there was
no objective evidence of impairment. On 30 June 20.15, Ukhozi estimated the lifetime expected
credit losses at R23 000.

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Other matters

1. Ukhozi has a financial liability that was designated to be measured at fair value through profit
or loss in terms of IFRS 9.4.2.2. The financial liability was incurred on 30 June 20.13 at
R1 400 000. This liability is neither a loan commitment nor a financial guarantee contract and
the separation of the credit risk component does not give rise to an accounting mismatch. The
fair value of this financial liability was as follows on the following dates:

Fair value Portion of fair value that relates to

the credit risk of Ukhozi
30 June 20.13 R1 400 000 R300 000
30 June 20.14 R1 550 000 R270 000
30 June 20.15 R1 640 000 R230 000

2. Ukhozi issued 1 000 compulsory convertible bonds on 1 July 20.14. The bonds have a three-
year contract term, and a face value of R 2 000 per bond. Interest is payable annually in
arrears at a nominal annual interest rate of 6% per annum. The compulsory convertible bonds
will be converted into Ukhozi ordinary shares on maturity date, in the ratio of one bond for two
ordinary shares. There is no option for cash settlement. On 1 July 20.14, a market-related
discount rate for a basic three-year debt instrument for Ukhozi Ltd is 10% per annum. You may
assume that the effective interest expense will be deductible for tax purposes and that there
are no temporary differences associated with the bonds.

3. Ukhozi invested in 200 000 ordinary shares of Speed Ltd (Speed) on 1 February 20.14 which
represents 10% of the issued shares of Speed. Ukhozi regards this investment as a strategic
investment. On initial recognition of the investment in Speed the management of Ukhozi
elected to present changes in the fair value of the equity instrument in other comprehensive
income using the mark-to-market reserve. The investment was acquired at fair value when the
share price of Speed’s ordinary shares was R6,20 per share. Transaction costs directly
attributable to the acquisition of the investment amounted to R23 000. The fair value of
Speed’s ordinary shares was as follows:

Fair value per share

30 June 20.14 R8,45
30 June 20.15 R8,80

For tax purposes the transaction costs are included in the tax base of the investment.

Additional information

• The retained earnings balance of Ukhozi on 1 July 20.14 amounted to R2 340 000.
• Ukhozi had R5 000 000 (100 000 ordinary shares) issued share capital on 1 July 20.14.
• Ukhozi profit after tax amounted to R3 765 000 for the year ended 30 June 20.15. The only
matter that must still be taken into account to calculate the final profit after tax amount is the
effect of the 1 000 compulsory convertible bonds issued.
• Assume Ukhozi elected early application of IFRS 9 Financial Instruments.
• The normal tax rate is 28% and capital gains tax inclusion rate is 80%.

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QUESTION 6

YOU NOW HAVE 57 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks

(a) Discuss the correct accounting treatment of the change in the business model of the 10
listed bonds (matter 1) in the financial records of Ukhozi Transport Ltd.

Please note:
• Your answer should not include any journals but should include the amounts
as specified in the information given.
• Ignore any normal income tax implications.

Communication skills: logical argument 1

(b) Provide the journal entries to account for the unlisted bonds (matter 2) in the 11
financial records of Ukhozi Transport Ltd for the year ended 30 June 20.15.

Please note:
• Journal narrations are not required, but dates are required.
• Ignore taxation.
• Round off all calculated effective interest rates to two decimals.

(c) Taking all matters referred to in the question into account, prepare the statement of 15
changes in equity in the financial records of Ukhozi Transport Ltd for the financial
year ended 30 June 20.15. The statement of changes in equity should commence
with the opening balances at 1 July 20.14. A total column is not required.

Communication skills: presentation and layout 1

Please note:

• Round off all amounts to the nearest Rand.

• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 6 - Suggested solution

(a) Reclassification date

In terms of the defined terms in Appendix A of IFRS 9 the reclassification date is the first date
of the first reporting period following the change in the business model.

The directors changed the business model on 30 April 20.15, therefore the reclassification date
is 1 July 20.15, the first day of the following reporting period. The reclassification journals will
be processed on 1 July 20.15. (1½)

According to IFRS 9.5.6.1 no restatement of previous amounts are allowed only prospective
changes. (½)

Reclassification of financial asset

Fair value

In terms if IFRS 9.5.6.4 if a financial asset is reclassified out of the amortised cost
measurement category and into the fair value through other comprehensive income (OCI)
measurement category, the fair value is determined at the reclassification date on 1 July 20.15.
(½)

Therefore the fair value determined on 1 July 20.15 is R1 050 000. (½)

Profit/loss

In terms if IFRS 9.5.6.4 any gain/loss arising from the difference between the previous
amortised cost of the listed bonds and the fair value is recognised in OCI.

The amortised cost balance of the listed bonds on 1 July 20.15 is (R1 000 000 – R100 000 +
R120 000) R1 020 000. (1½)

The fair value gain of R30 000 (R1 050 000 – R1 020 000) will be recognised in OCI. (1)

Effective interest rate

In terms if IFRS 9.5.6.4 the effective interest rate is not adjusted as a result of the
reclassification.

Therefore the effective interest rate of 12% (120 000/1 000 000) will remain unchanged for the
following financial period. (1)

Credit losses

In terms if IFRS 9.5.6.4 the measurement of the expected credit losses are not adjusted as a
result of the reclassification.

In terms of IFRS 9.B5.6.1(b) the measurement of expected credit losses will not change
because both measurement categories apply the same impairment approach.

Therefore the allowance for expected credit losses balance of R2 500 (R2 150 + R350) will not
be adjusted on reclassification date (1 July 20.15). (1½)

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Allowance for expected credit losses

In terms of IFRS 9.B5.6.1(b) if a financial asset is reclassified out of the amortised cost
measurement category and into the fair value through other comprehensive income (OCI)
measurement category, the allowance for expected credit losses will be derecognised and be
recognised as an accumulated impairment amount in OCI.

Therefore the allowance for expected credit losses of R2 500 will be derecognised and will no
longer adjust the gross carrying amount of the listed bonds. The R2 500 will instead be
recognised as an expected credit loss reserve in OCI on 1 July 20.15. (2)
Total (10)
Communication skills: logical argument (1)

COMMENT

Please note that reclassification is at an awereness level.

(b) Journal entries (matter 2)

Dr Cr
R R
31 December 20.14
J1 Bank (SFP) (1 000 x 100 x 12%) 12 000 (1)
Interest receivable (SFP)
[(98 500 x 12,63% x 6/12)] [C1] 6 221 (3½)
Interest income (P/L) (98 500 x 12,63% x 6/12) 6 221 (1)
Financial asset at amortised cost: unlisted bonds (SFP)
(balancing) 442 (1)
30 June 20.15
J2 Interest receivable (SFP) [(98 500 + 442) x 12.63% x 6/12)] 6 249 (2)
Interest income (P/L) 6 249 (½)
J3 Expected credit loss (P/L) (23 000 – 1 800) 21 200 (1½)
Allowance for expected credit losses - unlisted bonds 21 200 (½)
(SFP)
Total (11)

(c) UKHOZI TRANSPORT LTD

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 JUNE 20.15

Convertible
Ordinary Retained debentures Credit risk Mark-to
share change market
capital earnings equity reserve reserve
component
R R R R R
[C2] [C4] (5½)
Balance at 1 July 20.14 5 000 000 2 340 000 - 21 600 331 352
Total comprehensive income for the
year
- profit for the year - 1 - - (2)
3 743 514
- other comprehensive income - - - [C2]
28 800 [C4]
54 320 (4½)
Issue of convertible debentures
[C3] - - 1 701 578 - (3)
Balance at 30 June 20.15 5 000 000 6 083 514 1 701 578 50 400 385 672
Total (15)
Communication skills: presentation and layout (1)
1
3 765 000 - (29 842 [C3] x 72%) = 3 743 514 [2]

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CALCULATIONS

C1. Effective interest rate

PV = -98 500 (97 000 + 1 500)

PMT = 12 000
FV = 100 000
N = 3
I = 12,63% (calculated) [2]

C2. Financial liability at fair value through P/L

R
Fair value movement for the year ended 30 June 20.14:
Portion of movement that relates to credit risk (OCI)
(300 000 – 270 000) 30 000 [1]
Tax effect (30 000 x 28%) (8 400) [½]
21 600
[1½]
Fair value movement for the year ended 30 June 20.15:
Portion of movement that relates to credit risk (OCI)
(270 000 - 230 000) 40 000 [1]
Tax effect (40 000 x 28%) (11 200) [½]
28 800
[1½]

C3. Convertible bonds

Present value of the liability

N = 3 years [½]
I = 10% p.a. (market interest rate) [½]
PMT = (2 000 000 x 6%) = 120 000 [½]
FV = 0 (no cash option) [½]
COMP PV = ? 298 422
[2]

Financial liability 298 422

Equity component (balancing figure) 1 701 578 [½]
Proceeds 2 000 000 [½]

Interest expense for the year ended 30 June 20.15

1 AMORT (interest) 29 842 [1]
OR
(298 422 x 10%) = 29 842 29 842

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C4. Investment in Speed Ltd

Balance of mark-market reserve on 30 June 20.14 (1 July 20.14)

Fair value of shares on 30 June 20.14 (200 000 x R8,45) 1 690 000 [1]
Cost of shares [(200 000 x R6,20)+ (23 000)] (1 263 000) [1]
Mark-to-market reserve (OCI) 427 000
Tax effect (427 000 x 80% x 28%) (95 648) [1]
Net of tax 331 352
[3]
Movement in mark-to-market reserve on 30 June 20.15

Fair value of shares on 30 June 20.15 (200 000 x R8,80) 1 760 000 [1]
Fair value of shares on 30 June 20.14 (1 690 000) [1]
Mark-to-market reserve (OCI) 70 000
Tax effect (70 000 x 80% x 28%) (15 680) [1]
Net of tax 54 320
[3]

MJM
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QUESTION 7 26 marks

YOU HAVE 10 MINUTES TO READ THIS QUESTION

Giovanni Ltd was established in South Africa in 19.65. Over the years the company has grown to a
multi-national manufacturer and distributer of authentic Italian pasta. Giovanni Ltd’s pasta is made in
a traditional Italian style. Giovanni Ltd is a family owned bussiness and the five Giovanni brothers all
serve as directors on the board of Giovanni Ltd.

You are the financial manager of Giovanni Ltd. You are busy compiling the financial statements of
Giovanni Ltd for the year ended 31 December 20.13.

The following transaction must still be taken into account in the annual financial statements for the
year ended 31 December 20.13:

Issue of convertible debentures

Giovanni Ltd issued 5 000 9% debentures with a face value of R1 000 each at a discount of 5% on
30 June 20.13. Interest is payable on 31 December and 30 June. Each debenture is convertible on
30 June 20.18 at the option of the holder into 300 Giovanni Ltd ordinary shares. If a debenture is not
converted into shares, its face value will be paid out on maturity date. Giovanni Ltd paid transaction
costs (in cash) of R25 000 with regards to the issue of the debentures on 30 June 20.13. A fair rate
of return on debentures, without conversion rights, amounted to 11% on issue date.

Management is of the opinion that it is extremely likely that the conversion option will be exercised
by the debenture holders during the next 36 months.

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QUESTION 7

YOU NOW HAVE 39 MINUTES TO ANSWER THIS QUESTION

REQUIRED

Marks
(a) Discuss how the financial manager should classify the convertible debentures in 6
the financial statements of Giovanni Ltd for the year ended 31 December 20.13 in
terms of IAS 32 Financial instruments: Presentation.

Please note:
• Calculations are not required.
• Ignore any normal income tax implications.

Communication skills: logical argument 1

(b) Provide the financial manager of Giovanni Ltd with the journal entries to account for 13
the convertible debentures in Giovanni Ltd’s financial statements for the year
ended 31 December 20.13.

Please note:
• Journal narrations are not required.
• Ignore any normal income tax implications.

(c) Assume, for this part of the question only, that the management of Giovanni Ltd 5
elects that all interest-bearing financial liabilities are measured and carried at fair
value in terms of IFRS 9.4.2.2. Discuss the impact of this election on the
measurement and presentation of the convertible debentures.

Please note:
• Calculations are not required.
• Ignore any normal income tax implications.

Communication skills: logical argument 1

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QUESTION 7 - Suggested solution

(a) Convertible debentures

Giovanni Ltd (the issuer) issuer of the financial instrument needs to evaluate the terms (½)
of the financial instrument to determine whether it contains both a liability or an equity
component (IAS 32.28).

The terms of the convertible debentures issued by Giovanni Ltd contain the following
components:
Financial liability: (½)
• Giovanni Ltd has a contractual obligation to annualy deliver cash to the debenture
holders in the form of 9% per annum interest (coupons). (1½)
• Giovanni Ltd has a contractual obligation to repay the capital to the debenture
holders on 30 June 2018 should the holder decide accordingly. (1)
Equity component: (½)
• The holders’ right to convert to a fixed number of ordinary shares any time
before maturity (embedded written call option) is the equity component of the
debentures (IAS 32.29). (1)

Where a financial instrument contains a liability and an equity component such an

instrument is classified as a compound financial instrument (IAS 32.29). (½)

The classification of the liability and equity components of the convertible debentures
are not revised as a result of a change in likelihood that the coversion option will be
exercised (IAS 32.30). (1)

Giovanni Ltd’s contractual obligation to make future payments of interest and capital
remains outstanding until it is exstinghuised through conversion or maturity.
(IAS 32.30) (1)
Total (7½)
Maximum (6)
Communication skills: logical argument (1)

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(b) Journals

Dr Cr
R R

30 June 20.13
J1 Bank (SFP) [C1] or (5 000 000 x 95%) 4 750 000 (1)
Liability component of convertible debentures (SFP)
[C1] 4 623 119 (2½)
Equity component of convertible debentures (SFP)
[C1] 126 881 (1)
Recognise the convertible debentures issued
J2 Liability component of convertible debentures (SFP) [C2] 24 332 (1½)
Equity component of convertible debentures (SFP) [C2] 668 (1)
Bank 25 000 (½)
Recognise the transaction costs on the issue of the
convertible debentures
J3 31 December 20.13
Finance costs (P/L) [C3] 256 062 (4)
Bank (SFP) 225 000 (½)
Liability component of convertible debentures (SFP)
(balancing) 31 062 (1)
Recognise effective interest and interest paid
Total (13)

(c) Impact of IFRS 9.4.2.2 election on measurement and presentation

If Giovanni Ltd elects in terms of IFRS 9.4.2.2 to designate the financial liability as
measured at fair value, the gain or loss on the financial liability component of the
convertible debentures will be measured at fair value instead of amortised cost. (1)

The management of Giovanni is required to present the amount of the gain or loss
arising on the fair value measurement of the finanical liability component attributable to
changes in Giovanni’s credit risk in other comprehensive income (IFRS 9.5.7.7(a)). (1)

The remaining amount of the gain or loss arising on the fair value measurement of the
finanical liability component is presented in profit or loss. (1)

The equity component of the convertible debentures is not impacted by the election in
terms of IFRS 9.4.2.2 since equity is not re-measured subsequent to initial recognition
and measurement. (1)

Transaction costs incurred in relation to financial liabilities measured at fair value

through profit or loss are accounted for as an expense and not capitalised against the
carrying amount of the liability as when it is measured at amortised cost. (1)
Total (5)
Communication skills: logical argument (1)

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CALCULATIONS

C1. Convertible debentures

Calculation of present value of liability component

N = 10 (5 x 2) [½]
I = 5.5% (11%/2) [½]
PMT = 225 000 (5 000 000 x 9% x 1/2) [½]
FV = 5 000 000 (5 000 x R1 000) [½]
PV = 4 623 119
[2]

Financial liaibility component 4 623 119

Equity component (balancing) 126 881 [½]
Total proceeds (5 000 000 x 95%) 4 750 000 [½]
[1]

C2. Transaction costs on convertible debentures

Transaction costs to be capitalised 25 000

Financial liaibility (4 623 119 / 4 750 000 x 25 000) 24 332 [1]
Equity (126 881 / 4 750 000 x 25 000) 668 [½]
[1½]

C3. Finance cost

Calculation of effective interest rate

N = 10 (5 x 2) [½]
PV = 4 623 119 – 24 332[C2] = 4 598 787 [1]
PMT = -225 000 (5 000 000 x 9% x 1/2) [½]
FV = -5 000 000 (5 000 x R1 000) [½]
I = 5,57
[2½]

Finance costs 31 December 20.13:

1 Amort or (4 598 787 x 5.57%) 256 062 [1]

MJM
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QUESTION 8 20 marks

YOU HAVE 8 MINUTES TO READ THIS QUESTION

Electron Ltd manufactures electronic products and is listed on the JSE Limited. The financial
manager is currently on maternity leave and the group accountant was appointed as the acting
financial manager in the interim. The company’s financial year end is 31 December and the acting
financial manager is preparing for the year end reporting. The profit before tax is R6 540 000. The
financial manager is unsure of the application of International Financial Reporting Standards (IFRS)
in some instances and has approached you, an IFRS expert, to assist her with the following matters:

1. On 30 June 20.12 Electron Ltd purchased a non-controlling interest of 350 000 shares in
Racker Ltd, at R12,00 per share. The shares were purchased as a long-term investment.
Costs directly attributable to the transaction amounted to R20 000 and are recorded in other
expenses. On 31 December 20.12 the shares were valued by the directors at R13,50 per
share. On closer inspection it was noted that the fair value adjustment at 31 December 20.12
has not been accounted for.

At initial recognition, the management of Electron Ltd irrevocably elected to present changes in
the fair value of the investment in Racker Ltd in other comprehensive income using the mark-
to- market reserve.

2. On 1 January 20.11 Electron Ltd invested its surplus cash in listed bonds of Gables Ltd in
order to collect contractual cash flows of interest and the principle amount. The bonds were
purchased on the following terms:

Maturity date 31 December 20.15

Coupon interest rate 8% per annum
Interest payment date 31 December
Nominal value per bond R10 000
Number of bonds purchased 100
Redemption value At nominal value

The coupon interest payments have been received by Electron Ltd on time until
31 December 20.12.

On 31 December 20.12 the terms of the contract were renegotiated with the directors of
Gables Ltd. The financial manager correctly calculated the loss that occurred due to the
modification, this being R200 000. However, he was not certain how to account for the loss in
the financial statements.

The effective interest income for the year ended 31 December 20.12 has been correctly
accounted for in profit before tax before taking into account the renegotiated terms.

Electron Ltd determined that there were no significant increase in the credit risk of the bonds
by comparing the risk of default based on the modified contractual terms at reporting date with
the risk of default at initial recognition based on the original contractual terms. Electron Ltd
recognised a 12-month expected loss allowance of R50 200 for the year ended
31 December 20.12. This has been correctly accounted for in profit before tax.

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3. The accountant provided you with the share register of the company. From the share register,
you obtained the following information:

• 5 000 000 cumulative redeemable preference shares with a nominal value of R1 each
issued on 1 January 20.12. The dividend rate is a 12% cumulative preference dividend
per annum calculated on the nominal price, rolled up until redemption date. The
preference shares will be redeemed in cash after five years at nominal value. The
effective interest rate is 15% per annum was correctly calculated on the date of issue.

• 1 000 000 non-redeemable preference shares of R2 each. The dividends are

discretionary and a preference dividend of R200 000 was declared during the current
year.

• On 1 March 20.12, Electron Ltd issued 500 6% convertible bonds. The bonds mature
four years from date of issue and were issued at a face value of R1 000 each. Interest is
payable annually in arrears. The holder has the option to convert each bond into
250 shares at any time until the maturity date. If not converted into shares before
maturity date, the bonds will be settled in cash.The market related interest rate for bonds
without a conversion option was 9% per annum on 1 March 20.12.

The financial liability and equity components were correctly determined in accordance
with IAS 32 Financial Instruments: Presentation on 1 March 20.12 as follows:
R

Financial liability 451 404

Equity component 48 596
Total proceeds 500 000

4. During March 20.13 management decided to revise their investment strategy and as a result
the investment in Racker Ltd (refer to paragraph 1 above) was sold on 30 May 20.13. The
acting financial manager is of the opinion that the fair value adjustment on the investment
should be recorded in profit or loss, since it was sold within one year from date of purchase.

Additional information

• The normal income tax rate is 28% and the capital gains tax inclusion rate is 80%.
• A tax specialist employed by Electron Ltd calculated the income tax expense (after transaction
1 and 2 was correctly taken into account) as R1 690 000 to be recorded in the profit or loss
section.

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QUESTION 8

YOU NOW HAVE 30 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks
(a) Prepare an extract of the statement of profit or loss and other comprehensive 6
income of Electron Ltd for the year ended 31 December 20.12 commencing with the
line item profit before tax.
Communication skills: presentation and layout 1

Please note:
• The tax effects of items in other comprehensive income must be disclosed on
the face of the statement of comprehensive income.

(b) Calculate the interest expense that is included in the statement of profit or loss and 3
other comprehensive income of Electron Ltd for the year ended 31 December 20.12.

(c) Discuss the classification of the 12% cumulative redeemable preference shares in 5
the financial statements of Electron Ltd in terms of IAS 32 Financial Instruments:
Presentation.
Communication skills: logical argument 1

(d) Advise the acting financial manager about the treatment of the fair value 3
adjustments of the investment in Racker Ltd and the realisation of the mark-to-
market reserve for the financial year ending 31 December 20.13 in terms of IFRS 9
Financial Instruments.

Please note:
• Ignore normal income tax implications.

Communication skills: logical argument 1

Please note:

• Comparative figures are not required.

• Round off all amounts to the nearest Rand.
• Ignore Value Added Tax (VAT) implications.
• Your answers must comply with International Financial Reporting Standards (IFRS).

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QUESTION 8 - Suggested solution

(a) ELECTRON LTD

STATEMENT OF PROFIT OR LOSS AND COMPREHENSIVE INCOME FOR THE YEAR

ENDED 31 DECEMEBER 20.12

R
Profit before tax [C1] 6 360 000 (2)
Income tax expense (given) (1 690 000) (½)
PROFIT FOR THE YEAR 4 670 000

Other comprehensive income

Items that will not be reclassified to profit or loss:
Mark-to-market reserve 391 880
Gains on remeasurement of financial assets [C2] 505 000 (2½)
Income tax (505 000 x 80% x 28%) (113 120) (1)
Other comprehensive income for the year 391 880
TOTAL COMPREHENSIVE INCOME FOR THE YEAR 5 061 880
Total (6)
Communication skills: presentation and layout (1)

(b) Interest expense

Preference dividend on redeemable preference shares

(4 497 1771 x 15%) 674 576 (1½)
Interest on convertible bonds ( 451 404 (given) x 9% x 10/12) 33 855 (1½)
708 431

1 N = 5 years
I = 15%
PMT = (5 000 000 x 12%) = 500 000
FV= 5 000 000
PV = 4 161 961
Total (3)

(c) Classification of the 12% cumulative redeemable preference shares

On initial recognition the instrument should be classified in accordance with substance

of the contractual arrangement and the definition of a financial liability, a financial asset
and an equity instrument (IAS 32.15).
In determining whether a preference share is a financial liability or equity instrument, an
issuer assesses the particular rights attached to the share to determine whether it
exhibits the fundamental characteristics of a financial liability (IAS 32.AG25).

IAS 32 requires that the two cash flow streams (component parts) of preference shares,
namely dividends and principal, be considered separately for classification as equity or
a financial liability.

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Principal amount

• A financial liability according to IAS 32 is any liability that is a contractual

obligation to deliver cash/financial asset to another party, or to exchange financial
instruments under unfavourable conditions, or a contract that may be settled in
own equity instruments.

• There is a contractual obligation to deliver cash as the preference shares are

redeemable. (1)

• Therefore, the principal amount meets the definition of a financial liability. (½)

Dividend stream

• Since the preference share agreement contains a redemption feature, all

accumulated (unpaid) dividends will roll up until redemption date and will have to
be paid on 31 December 20.16 when the preference shares are redeemed.
Therefore based on the substance of the transaction, Electron has a contractual
obligation to declare and pay all preference dividends on or before
31 December 20.16. In light of this, the preference dividends are classified as a
financial liability. (3)

Conclusion

• Therefore the preference shares issued by Electron Ltd should be classified as a

financial liability. The dividends will be treated as finance cost in profit or loss. (1)
Total (6)
Maximum (5)
Communication skills: logical argument (1)

(d) ELECTRON LTD

At initial recognition an entity may make an irrevocable election to present in other

comprehensive income subsequent changes in the fair value of an investment in equity
instrument that is not held for trading (IFRS 5.7.5).

At initial recognition Electron Ltd made an irrevocable decision to present fair value
changes of the investment in shares in other comprehensive income. (1)

The above election is appropriate since the investment in shares is held as a long-term
investment and is not held for trading. (½)

The changes should therefore remain in other comprehensive income and not be (½)
recorded in profit or loss.

The correct accounting treatment should be:

• The fair value adjustment up to 30 May 20.13 should be recorded in other

comprehensive income. (½)

MJM
 85 FAC4861/103
NFA4861/103
ZFA4861/103

Fair value adjustments recorded in the mark-to-market reserve after the sale of
investment shall not be subsequently transferred to profit or loss. (IFRS 9.B5.7.1) (½)

• The entity may transfer the cumulative gain or loss from the mark-to market
reserve to another component of equity. (½)
Total (3½)
Maximum (3)
Communication skills: logical argument (1)

CALCULATIONS

C1. Profit before tax

Profit before tax (given) 6 540 000 [½]

Add back transaction costs (given) 20 000 [½]
Loss on modification of financial asset at amortised cost: bonds (given) (200 000) [1]
6 360 000
[2]

C2. Investment in Racker Ltd

Fair value of shares on 30 June 20.12 ((350 000 x 12) + 20 000) 4 220 000 [1½]
Fair value of shares on 31 December 20.12 (350 000 x R13,50) 4 725 000 [1]
Fair value adjustment 505 000
[2½]

COMMENT

Please read IAS 32.AG 26 regarding non-redeemable preference shares and distribution
of the preference dividends at the discretion of the issuer.

MJM