This question tested the accounting of monetary instruments, especially an asset held at reasonable value through loss or profit. The preparation of the journal for subsequent and initial measurement tested three key areas - treatment of transaction costs, the subsequent measurement at fair value and the recording of the loss/gain through profit or loss in the period.
The second part of the question tested the classification and initial recording of a changeable instrument and then successive measurement of the liability element. This tested the candidates understanding of the substance of instruments and then the detailed working of amortised cost which is a key computation for investments and liabilities at F2.
Recommended approach
Candidates should have prepared as a minimum two journal entries - one showing the amount of uplift in value with the gain recorded in profit for the period and the second on initial recording of the investment with transaction costs being written off to p/l.
The First part of the question required some narrative representing that candidates knew why the recording of the instrument would be split - equity and liability.
Although no initial journal entry was vital, candidates had to calculate the opening value of the liability to allow them to subsequently measure the liability using amortised cost.
Candidates should have relied on their indulgent of PV measuring to ascertain the PV of the principal amount of the liability and the PV of the interest income. The remaining balance should then have been clearly categorized to equity - candidates could have prepared a journal entry to exemplify their answer, although it was not purposely required.
(a) (i) Initial recording
Dr investment - HFT asset $600,000
Dr finance costs in profit or loss $30,000
Cr bank $630,000
Being the recording of 100,000 shares purchased at $6 per share and writing off the related transaction costs of $30,000 to profit or loss, as the investment is held for trading.
Subsequent measurement
Dr investment - HFT asset $40,000
Cr profit or loss - gain $40,000
Being the uplift in value in the HFT asset at 31 December 2012 ($640,000 - $600,000)
(b) (i) IAS 32 requires that the liability and equity elements within convertible instruments be initially recognised individually. The preliminary carrying amount of the liability is estimated by measuring the reasonable value of a similar instrument that has no conversion element. This is achieved by calculating the present value of the future cash flows related with the instrument assuming that it is not converted on deliverance (ie: the interest and principal repayment cash flows) discounted at the prevailing market rate for a related instrument without conversion rights. The diversity between this amount and the proceeds of issue (ie: the residual) is recognised as equity.
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(ii) Value of liability as at 31 December 2013 Opening balance
$000
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Finance cost at 8%
$000
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Interest paid 6%
$000
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Closing balance
$000
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9,206 (W1)
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737
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(600)
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9,343
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Working 1 Liability element
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$000
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PV of the principal (at 8% for 5 years) = ($10m x 0.681)
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6,810
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PV of interest of 6% on $10m for 5 years = ($10m x 0.06 x 3.993)
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2,396
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Total value of liability element
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9,206
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