ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing
Подождите немного. Документ загружается.
Chapter 11: Financial assets and financial liabilities
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 195
The method to use is to calculate the equity element as the residual after
determining the present value of the debt element:
The present value of the interest payments and the redemption value of the
convertible is found using a market interest rate for similar debt finance which is
not convertible (normally a higher interest rate as there is no conversion
element).
Compare this present value to the proceeds of the bond issue to find the residual
equity element.
Example
A company issues $10 million of 6% convertible bonds at par. The bonds are
redeemable at par after four years or can be converted at any time up to that date
into 20 ordinary shares for every $100 of bonds. The market rate of interest for
similar debt which is not convertible is 8%.
Required
Show how the bonds should be recorded on issue in the statement of financial
position.
Answer
Calculate the present value of debt element using the prevailing market interest rate of
8%.
$
Presentvalueofinterestpayments
10,000,000×6%×discountfactorat8%fortimeperiods1to4
=$600,000×3.312 1,987,200
Presentvalueofprincipalpayableattheendoffouryears
$10,000,000×discountfactorat8%attime4
$10,000,000×
0.735 7,350,000
–––––––––
Valueofdebtelement 9,337,200
Totalproceeds 10,000,000
–––––––––
Valueofequityelement(residual) 662,800
–––––––––
Inthestatementoffinancialpositionthesefigureswouldappearas:
$
Non‐currentliabilities
Convertiblebonds 9,337,200
Equity
Sharecapital 662,800
Paper F7: Financial reporting (International)
196 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
Recognition and measurement of financial instruments
Recognition
Initial measurement
Classification
Subsequent measurement
Treatment of gains and losses on subsequent measurement
Summary: measurement and gains or losses on re-measurement
3 Recognition and measurement of financial
instruments
3.1 Recognition
A financial asset or a financial liability should be recognised in the statement of
financial position when the reporting entity becomes a party to the contractual
provisions of the instrument.
This is different from the normal recognition criteria for an asset or a liability. The
IASB Framework states that an item should be recognised when there is a probable
inflow or outflow of economic benefits.
The effect of this is that all financial assets and liabilities, including derivatives, are
recognized in the statement of financial position, even if they have no cost.
For example, an entity takes out a forward contract to buy a specified amount of
foreign currency at a fixed price on a future date. (This contract is a type of financial
derivative.) The entity recognises the contract on the commitment date, when the
contract is made, instead of waiting until the foreign currency is actually purchased.
3.2 Initial measurement
A financial asset or liability should initially be measured at cost.
This is the fair value of the consideration given or received.
3.3 Classification
Classification of financial assets
Financial assets are investments in financial instruments and receivables. After
initial recognition, financial assets are classified into four categories. The way in
which they are measured depends on the category in which they are placed. The
four categories or classifications are:
Financial assets at fair value through profit or loss
Chapter 11: Financial assets and financial liabilities
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 197
Held-to-maturity investments
Loans and receivables
Available-for-sale financial assets
Financial assets at fair value through profit or loss
These consist of:
financial instruments held for trading; and
all derivatives.
A financial instrument is held for trading if it is:
acquired principally for the purpose of selling or repurchasing it in the near
future; and
part of a portfolio of instruments that are managed together.
An entity can choose to treat other financial instruments as ‘at fair value through
profit or loss’, provided that they meet certain criteria.
Equity instruments that do not have a quoted price in an active market cannot be
included in this category.
Held-to-maturity investments
Held-to-maturity investments are financial assets
with fixed or determinable payments
and fixed maturity
that an entity has the positive intent and ability to hold to maturity.
Loan stock, redeemable preference shares and bonds issued by other entities would
fall into this category, provided that the entity plans to hold the investment to the
end of its term (for example, until the financial instrument is redeemable). The
entity must also expect to have sufficient cash or other resources available, so that it
will not be forced to sell the investment before the end of its term.
Loans and receivables
These are financial assets
with fixed or determinable payments
that are not quoted in an active market
that the entity does not intend to sell in the near future (this would mean that
they are held for trading)
and the entity expects to recover the full amount.
This category could include loans made to other entities, trade receivables and
investments in bonds and other forms of debt, provided that the other conditions
are met.
Paper F7: Financial reporting (International)
198 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
Available-for-sale financial assets
These are any other financial assets that do not fall into any of the three categories
above. In addition, an entity can designate an asset as available-for-sale when it is
first recognised.
Classification of financial liabilities
Financial liabilities basically fall into two categories:
financial liabilities ‘at fair value through profit or loss’ (explained above); and
other financial liabilities.
3.4 Subsequent measurement of financial instruments
Subsequent measurement of financial assets
After initial recognition, financial assets are all measured at fair value, with the
following exceptions:
Held-to-maturity investments. These are measured at amortised cost using the
effective interest rate. Amortised cost was explained earlier in the chapter.
Loans and receivables. These are also measured at amortised cost using the
effective interest rate. (However, there is no requirement to discount trade
receivables to a present value if they are a current asset.)
Investments in equity instruments that do not have a quoted price in an active
market and whose fair value cannot be reliably measured. Equity instruments
whose fair value cannot be reliably measured are measured at cost.
Subsequent measurement of financial liabilities
After initial recognition, financial liabilities at fair value through profit or loss are
measured at fair value.
Other financial liabilities are measured at amortised cost.
3.5 Treatment of gains and losses on subsequent measurement
When financial assets or liabilities are re-measured, there will be a gain or loss,
which must be accounted for.
The treatment of any gain or loss depends on the category of the financial asset or
liability.
Financial assets and financial liabilities at fair value through profit and loss.
Changes in fair value (gains and losses) are recognised in profit or loss.
Available-for-sale financial assets. These are also measured at fair value, but
changes in fair value are recognised as ‘other comprehensive income’, not in
profit or loss. Dividends and interest received from these assets are recognised
as income in profit or loss. When an available-for-sale financial asset is sold, the
Chapter 11: Financial assets and financial liabilities
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 199
total gain or loss recognised in other comprehensive income to date should be
re-classified. When this happens a re-classification adjustment is required, and
the total gain (or loss) is reported in profit or loss for the period in which the
disposal occurs, and to prevent double-counting of the gain, there should be a
matching deduction in ‘other comprehensive income’.
Assets and liabilities measured at amortised cost: Changes in value (which
might occur if there is a change in interest) are recognised in profit or loss.
3.6 Summary: measurement and gains or losses on re-measurement
Measurement Gains and losses/ changes
in value
Financial assets and liabilities at
fair value through profit or loss
Fair value Recognised in profit or loss
Held-to-maturity investments Amortised cost Recognised in profit or loss
Loans and receivables Amortised cost Recognised in profit or loss
Available-for-sale financial
assets
Fair value Recognised in other
comprehensive income,
until the asset is sold. On
sale, total gains are re-
classified as profit or loss.
Other financial liabilities Amortised cost Recognised in profit or loss
Measurement of financial liabilities in the examination
You might be given an examination question that asks specifically about the
measurement/valuation of financial assets or liabilities. It is also quite possible that
you will be given a question in which the measurement of a financial liability is just
one item to be dealt with.
For example, you might be asked to account for a financial liability that will be
redeemed at a large premium. Loans are valued at amortised cost and any changes
in value are recognised in profit or loss. You might be required to re-measure the
amount of a loan and the amount to charge in finance costs for the year.
Example
It is 30 June Year 2. A company issued a loan note on 1 July Year 1. The loan note is
for $10 million and interest is payable at a coupon rate of 4%. It is redeemable on 30
June Year 7 at a large premium. The large premium on redemption is to compensate
the lender for the fact that the coupon rate of interest is very low. It has been
calculated that the effective annual rate of interest, allowing for the premium on
redemption, is 6%.
Paper F7: Financial reporting (International)
200 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
A trial balance at 30 June Year 2 includes the following balances:
Debit
Credit
$
$
4% loan note
10,000,000
Loan interest paid 400,000
Required
State the amount at which the loan note should be stated in the statement of
financial position as at 30 June Year 2.
State the amount of the finance cost for the loan note to include in profit or loss for
the year to 30 June Year 2.
Answer
The loan note should be valued at amortised cost. The actual interest paid was
$400,000 but the effective interest rate is 6%. Since the loan note was only issued on 1
July Year 1, the calculation of the amortised cost of the loan is as follows:
Liabilityat
beginning
ofyear
Finance
chargeat6%
Interest
paid
Outstanding
liabilityatend
ofyear
$ $ $ $
Yearto30JuneYear2 10,000,000 600,000 (400,000) 10,200,000
The loan should be stated in the statement of financial position at 30 June Year 2 as
$10, 200,000.
The finance charge for the year (an expense in profit or loss) should be $600,000.
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 201
Paper F7 (INT)
Financial reporting
CHAPTER
12
Leases
Contents
1 Types of lease
2 Accounting for a finance lease
3 Accounting for an operating lease
4 Leases: disclosure requirements
Paper F7: Financial reporting (International)
202 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
Types of lease
Debt and equity
Finance leases and operating leases
Leases of land and buildings
1 Types of lease
1.1 The characteristics of a lease
A lease is a way of getting the use of a non-current asset, such as a machine, without
purchasing it outright. Entity X (the ‘lessor’) owns the asset and hires it out to Entity
Y (the ‘lessee’). The terms of the lease give the lessee the right to use the asset for a
specified period of time.
For example, Grey Sky Airways might lease an aeroplane from Big Wings Aero
Company (BWA). Under the terms of the lease agreement, Grey Sky may agree to
pay a fixed annual rental of $1,000,000 for the exclusive use of the aeroplane for a
period of eight years. Grey Sky Airways is the lessee, who uses the aeroplane. BWA
is the lessor, who receives the annual rental payments. BWA is the legal owner of
the aeroplane, even though Grey Sky has exclusive use of it during the term of the
lease.
The lease agreement may also provide for the purchase of the aeroplane by Grey
Sky from BWA, at the end of the lease agreement.
Similarly, Small Printing Company (SPC) may lease a photocopier machine from
Office Metal Supplies (OMS) and under the terms of the lease, SPC may agree to pay
$300 each month for the exclusive use of the photocopier, for a period of one year.
SPC is the lessee, and OMS is the lessor and legal owner of the photocopier.
A lease is defined in IAS17 as: ‘an agreement whereby the lessor conveys to the
lessee in return for a payment or series of payments the right to use an asset for an
agreed period of time.’
1.2 Finance leases and operating leases
IAS17 Leases deals with the accounting treatment of leased assets in the financial
statements of lessees and lessors. Under IAS17 Leases there are two types of lease:
finance leases, and
operating leases.
Each type of lease is accounted for in a different way. The terms of the lease
agreement determine the type of lease.
Chapter 12: Leases
© EWP Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides 203
A finance lease is a lease that transfers substantially all the risks and rewards of
ownership to the lessee. This means that the lessee is responsible for ‘risks’ such as
insuring and maintaining the asset but also has the ‘rewards’ of ownership, which
come from using the asset to generate revenue.
An operating lease is defined in IAS17 as a lease other than a finance lease.
Identifying a finance lease
IAS17 gives some guidance on how leases should be classified, by giving examples
of situations that would normally lead to a lease being classified as a finance lease.
A lease will normally be a finance lease in any of the following circumstances.
At the end of the term of the lease, the legal ownership of the asset will be
transferred from the lessor to the lessee, under the terms of the lease agreement.
The lessee has the option at a future date to purchase the asset from the lessor,
and the agreed purchase price is substantially lower than the expected fair value
of the asset at the date the option to buy can be exercised. (In this situation, it is
therefore probable that the lessee will exercise the option to buy the asset.)
The term of the lease is for a major part of the expected economic life of the asset.
At the beginning of the lease, the present value of all the future lease payments
amounts to substantially all of the fair value of the leased asset, or more.
The leased asset is of such a specialised nature that it can only be used by the
lessee (without the need for a major modification).
In all these situations, it can normally be concluded that substantially all the risks
and rewards incidental to ownership are transferred to the lessee.
Example
An entity leases an asset. The lease is for three years with payments of $5,000
annually. The fair value of the asset is $13,000 and the present value of the
minimum lease payments is $12,886. The useful life of the asset is 3 years and the
entity is responsible for maintaining and insuring the asset.
This lease is a finance lease.
The present value of the minimum lease payments is 99% (substantially all) of
the fair value of the leased asset.
The lease is for the whole of the useful life of the asset.
The lessee is responsible for maintaining and insuring the asset.
The substance of the lease agreement is that the lessee holds the asset. The lease is
effectively a financing arrangement.
1.3 Leases of land and buildings
Under IAS17 a lease of land and buildings should be split into its separate parts.
There is a lease on the land and a different lease on the building. The lease
Paper F7: Financial reporting (International)
204 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP
payments should therefore be divided between payments on the land and payments
on the building.
Because land has an infinite life, it is highly unlikely that the risks and rewards
of ownership will be transferred to the lessee. Therefore the land element of such
a lease will normally be classified as an operating lease.
Whether the buildings element of the lease is classified as a finance lease or an
operating lease will depend on the terms of the lease.