FAC4861/103/0/2023

NFA4861/103/0/2023
ZFA4861/103/0/2023

Tutorial letter 103/0/2023

ADVANCED FINANCIAL ACCOUNTING I

FAC4861/NFA4861/ZFA4861

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 for guidance purposes only. Kindly
note that no marks are awarded for the theory.

Write neatly, use bullet points where possible to ensure that you obtain the marks for
presentation!

MJM
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DUE DATE
TEST 2 ON TUTORIAL LETTER 102 - 103 9 MAY 2023

REMARK DEADLINE: 17 JUNE 2023

PERSONNEL AND CONTACT DETAILS

Personnel Telephone
number
Lecturers
Ms K Mohajane (Module Coordinator) 012 429 4688
Ms Y Abed 012 429 4713
Mr Y Madolo
Mr D Makhunamisha 012 429 3111
Mr H Meyer 012 429 4722
Mr C Ngele
Ms A Uys 012 429 4750

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 additional questions 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

MARCH/APRIL 2023
WEDNESDAY THURSDAY FRIDAY SATURDAY SUNDAY MONDAY TUESDAY
29 30 31 1 2 3 4
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

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INDEX

1. OVERVIEW OF IAS 32

Financial instrument: presentation SAICA level Leaning unit section

Definitions Level 3 7.2

Definitions

Financial instruments
Financial assets
Financial liability
Equity instrument

Liabilities and equities 7.3

No contractual obligation to deliver cash or Level 3
another financial asset
Settlement in the entity’s own equity instrument Level 3
- variable number of its own equity instruments
Presentation

- fixed number of its own equity instruments

Contracts (options) on own equity instruments Level 1
Contingent settlement provisions Level 3 7.3
Compound financial instrument Level 3
Treasury shares Level 3
Interest, dividends, losses and gains Level 3
Offsetting a financial asset and a financial
Level 3
liability

The following are concepts and topics of IAS 32 Financial Instruments: Presentation excluded from
the 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 Excluded
the main body in the standard.

MJM
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2. OVERVIEW OF IFRS 9

Financial instruments SAICA level Learning unit section

Definitions Level 3 7.5

12-month expected credit losses
Amortised cost
Credit impaired financial asset
Credit loss
Derivative
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 Level 3

Recognition and
derecognition

- First-day gains and losses Level 1

Derecognition of financial assets Level 3 7.6

Derecognition of financial liability Level 3
- Exchange od debt instrument Leve 1

Financial assets Level 3

- At amortised cost
- At FVTOCI
- At FVTPL
Classification

Financial liabilities Level 3 7.7

- At FVTPL

Embedded derivatives Excluded only pertaining to

liabilities

Reclassification Level 1

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Financial instruments SAICA level Learning unit section

Initial measurements Level 3

Subsequent measurements
-financial assets Level 3
-financial liabilities Level 3

Amortised cost Level 3

-Modifications Level 1
-Write-offs Level 1
Measurement

Impairments
Recognition of expected credit losses Level 3 7.8
Identify when a significant increase in credit Level 1
risk occurs or when credit impaired Level 3
Modified financial assets Level 3
Simplified approach Level 3
Measurement of expected credit losses Level 3

Reclassification of financial assets Level 1

Gains and losses Level 3

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

The following concepts and topics of IFRS 9 Financial Instruments are 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.

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 Level 3 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
Level 3.

Forward exchange contract

A forward exchange contract (FEC), commonly known as an 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 which 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.

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

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IAS 32 Financial Instruments: Presentation

7.1 Scope (Level 1)

Refer to IAS 32.4 – 32.10.

7.2 Definitions (Level 3)

Refer to IAS 32.11 – 32.14.

Concepts and topics (IAS 32) Level of examination

Definitions
• Purchased or originated credit-impaired financial assets Excluded
• All definitions relating to hedge accounting Excluded

7.3 Presentation (Level 3)

Refer to IAS 32.15 – 32.95.

Concepts and topics (IAS 32) Level of examination

Presentation
• Puttable instruments and obligations arising on liquidation Excluded
(par. 16A-16F & 22A)

Examples

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.

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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.

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

Provide an explanation to the financial directors of Global Ltd and Excel Ltd of how the 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).

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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).

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).

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).

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).

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.
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).
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)
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).
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).

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).

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.
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).
Accordingly, the share options issued by Global are equity instruments in accordance with
IAS 32.22.

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.
The investment in the shares will only be recognised as a financial asset of Excel when the
share options are exercised (IAS 32.AG17).

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

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.
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.
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.
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.
In light of the above, the preference dividends contain a financial liability.

Conclusion
The preference shares are classified as a financial liability (IAS 32.11 and IAS 32.18a).
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.

Excel’s financial statements (holder):

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

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:
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
preference shares). This feature makes non-redeemable preference shares very similar to
equity.

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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.
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).
Accordingly, the preference dividends are similar to ordinary dividends (equity).

Conclusion
Accordingly, the preference shares should be classified as equity instruments.

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.

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).

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.
Therefore, in terms of the agreement, Global has no contractual obligation to deliver cash or
a financial asset to Excel on conversion date.
Global is, however, required to deliver its own shares (equity instruments) to Excel on
conversion date.
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).
In light of the above, the principal amount contains an equity instrument.

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.
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.
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.
In light of the above, the preference dividends contain a financial liability.

Conclusion
The preference shares are classified as a compound financial instrument as it contains
both an equity and a liability component (IAS 32.28).
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).

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.

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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 a 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.
It has to be determined if the uncertain future event (the rise in future revenue) is within the
control of Global and Excel.
In terms of IAS 32.25 the issuer’s future revenues are not within the control of the issuer
and the holder.
In the light of this, Global does not have an unconditional right to avoid delivering cash on
maturity date.
Therefore, the debentures are classified as a financial liability in terms of the contingent
settlement provisions of IAS 32.25.

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.

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”).
In terms of South African legislation, the shares reacquired by Global must be cancelled as
issued share capital.
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.
No gain or loss is recognised in profit or loss on the share buy-back.
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).

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.

MJM
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IFRS 9 Financial Instruments

7.4 Scope (Level 1)

Refer to IFRS 9.2.1 – 9.2.7.

7.5 Definitions (Level 3)

Refer to IFRS 9 Appendix A.

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

7.6 Recognition and derecognition (Level 3)

Refer to IFRS 9.3.1.1 – 9.3.3.5.

Concepts and topics (IFRS 9) Level of examination

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

7.7 Classification (Level 3)

Refer to IFRS 9.4.1.1 – 9.4.4.3.

Concepts and topics (IFRS 9) Level of examination

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

7.8 Measurement (Level 3)

Refer to IFRS 9.5.1.1 – 9.5.7.11.

Concepts and topics (IFRS 9) Level of examination

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

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Examples

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 at 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 at R10,50 per
share on 1 January 20.11. The 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 R250 000 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.

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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.

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 are 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 objectives of the business model.

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 are 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.

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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.

REQUIRED

(a) Provide all the journal entries in the records of Spilkin Ltd since acquisition or 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 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).

Suggested solution

Transaction 1
Dr Cr
R R
1 June 20.12
J1 Financial asset at fair value through P/L (SFP) 250 000
Transaction costs (P/L) 2 500
Bank (SFP) [(20 000 x 12,50) + 2 500] 252 500
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
Financial asset at fair value through P/L (SFP) 30 000
Fair value adjustment at year end
31 December 20.13
J3 Financial asset at fair value through P/L (SFP) 10 000
Fair value adjustment (P/L) [(20 000 x 11,50) – 220 000] 10 000
Fair value adjustment at year end

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.

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Transaction 2

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

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
Bank (SFP) 150 000
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
Mark-to-market reserve (OCI) 10 000
Remeasurement of investment to fair value on date of sale
J3 Bank (SFP) (160 000 – 1 500) 158 500
Selling expenses (P/L) 1 500
Financial asset at fair value through OCI (SFP) 160 000
Sale of investment in Silver Ltd

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.

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Transaction 4 Dr Cr
R R
1 January 20.12
J1 Bank (SFP) [C1] 250 000
Liability component: debentures (SFP) [C1] 233 629
Equity component: debentures (SCE) [C1] 16 371
Convertible debentures issued
31 December 20.12
J2 Finance costs (P/L) [C2] 37 381
Bank (SFP) [C2] 35 000
Liability component of convertible debentures (SFP)
[C2] 2 381
Recognise effective interest and interest paid
31 December 20.13
J3 Finance costs (P/L) [C2] 37 762
Bank (SFP) [C2] 35 000
Liability component of convertible debentures (SFP)
[C2] 2 762
Recognise effective interest and coupon interest paid

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
I = 16% (market interest rate)
PMT = 35 000 (250 000 x 14%) (coupon rate)
FV = 250 000
PV = 233 629

Financial liability 233 629

Equity (balancing figure) 16 371
Total 250 000

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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

31 December 20.13 236 010 37 762 (35 000) 238 772
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
Day one gain on acquisition of debentures (P/L) 77 109
Bank (SFP) [(10 000 x 80) + 2 000] 802 000
Initial recognition of investment in debentures at fair
value
J2 Expected credit loss (P/L) 2 500
Allowance for expected credit losses (SFP) (given) 2 500
Recognition of 12-month expected credit loss allowance
31 December 20.12
J3 Bank (SFP) [C1] 80 000
Financial asset at amortised cost: debentures (SFP)
(balancing) 5 334
Interest income (P/L) [C1] 74 666
Recognise effective interest income and interest income
received
J4 Expected credit loss (P/L) 1 000
Allowance for expected credit losses (SFP)
(3 500 – 2 500) 1 000
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).

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

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
PV = (877 109 + 2 000) = (879 109)
PMT = 80 000 (10 000 x 80 x 10%) (coupon rate)
FV = 800 000 (10 000 x 80)
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

31 December 20.13 873 775 74 212 (80 000) 867 987

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

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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
PV = (877 109 + 2 000) = (879 109)
PMT = 80 000 (1 000 000 x 8%) (coupon rate)
FV = 1 000 000
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

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

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
1-30 days past due 543 000 1,1% 5 973
31-60 days past due 362 000 3,1% 11 222
61-90 days past due 271 500 6% 16 290
More than 90 days past due 181 000 13% 23 530
Total 5 430 000 69 233

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

C1. Settlement with equity instruments

Effective interest rate

N = 4 years
PV = (98 500)
PMT = 33 475
FV = 0
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

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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ADDITIONAL QUESTIONS
QUESTION 7.1 (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 losses 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 7.1 – 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]

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QUESTION 7.2 (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).

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QUESTION 7.2 - 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 currency (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 The Wife Ltd Test 2/2022 40 Financial instruments 34

2 Zile Holdings Ltd Test 2/2021 40 Financial instruments 41

3 Zwonke Wonke Ltd Test 2/2020 40 Financial instruments 48

4 Macko Ltd Test 2/2019 40 Financial instruments 55

5 Stein Oops Ltd Test 2/2018 40 Financial instruments 63

MJM
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QUESTION 1 40 Marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

The Wife Limited (The Wife) is a listed company on the main board of JSE. The Wife CEO
Nkosana Zulu signed a contract between the company and Eksom to assist in the supply of
electricity in the country, the contract was entered on the 1 March 20.21. The Wife engaged
Mozambique to supply coal to them in order to generate sufficient electricity to capacitate the power
supply to citizens and business.

Board chairperson Mr Nqoba Zulu approved a strategy presented by the CEO to raise funds in order
to be able to invest/purchase the coal from Mozambique. The Wife year end is 28 February 20.22.

You are a Consultant and a financial instrument expert seconded to the company. You are
requested to assist the finance team in wrapping up issues in preparation of financial statement and
below are the outstanding matters:

1. The Wife acquired an investment in listed bonds on 1 March 20.21. The listed bonds are held
by The Wife within a business model whose objective is to collect contractual cash flows of
interest and the principal amount. The classification and measurement of the investment in
listed bonds were correctly accounted for in the financial statements of The Wife for the year
ended 28 February 20.22.

The financial manager of The Wife is unsure about the calculation and measurement of the
loss allowance for expected credit losses of the investment in listed bonds for the year ended
28 February 20.22. He asked for your assistance in this regard. The financial manager
provided you with the following schedule from the company’s actuary containing the
information relevant to the bonds:

ABC Actuaries

Date: 10 March 20.22

Dear financial manager of The Wife Ltd

We assessed the investment in listed bonds acquired by you on 1 March 20.21 and
determined the following:

Credit risk on 28 February 20.22 Low risk

Present value on 28 February 20.22 of contractual cash flows on the listed R920 520
bonds in terms of the bond contract.
Present value on 28 February 20.22 of expected contractual cash flows on the R899 320
listed bonds over the contract term of the bonds, based on the risk or
probability of default occurring over the expected life of the bonds.

We estimate that there is a very low possibility of a credit loss occurring on the
listed bonds.
Probability of default occurring between 1 March 2022 – 28 February 20.23 0.5%

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In our assessment above, we made use of reasonable and supportable information about past
and current conditions as well as forecasts on the listed bonds available to us. We trust the
above calculation will assist with your accounting of the listed bonds.

Yours sincerely
Mr X Majola

2. On 3 March 20.21, The Wife Ltd issued 500 000 non-redeemable preference shares at R10
per share to Hlomu Ltd. Dividends are non-cumulative and solely at the discretion of the
directors. A discretionary dividend of R240 000 was declared for the year ended
28 February 2022.

3. On 1 September 20.21, The Wife Ltd issued 3 000 8% convertible debentures with a face
value of R1 000 each at a discount of 5%. The transactions costs incurred were R35 000.
Interest is payable semi-annually on 31 August and 28 February. On 28 February 20.25 each
debenture will be convertible at the option of the debenture holder. The debentures will either
be convertible into 100 ordinary shares for each debenture held or will be settled in cash. On
date of issue, the market interest rate for similar debentures without conversion rights was
11%.

4. On 8 September 20.21, The Wife sold its equity investment in MaxShow Ltd at a fair value of
R9 500 000. The investment was acquired on 1 June 2020 by The Wife as a 10% equity
investment in MaxShow Holdings Ltd for R8 622 500 including transaction costs of R122 500.
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 28 February 20.21 was R8 800 000.

It is the policy of The Wife 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.

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QUESTION 1

YOU HAVE 60 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks
(a) Discuss the recognition and measurement of the expected credit losses on the 10
investment in listed bonds in the financial statements of The Wife Ltd for the year
ended 28 February 20.22 in accordance with IFRS 9 Financial Instruments. Your
answer should include calculations.

Communication skills: logical argument 1

(b) Discuss the classification of the non-redeemable preference shares in the financial 5
statements of The Wife Ltd for the year ending 28 February 20.22.

(c) Provide the journal entries to record the debentures in the records of The Wife Ltd for 12
the year ended 28 February 20.22.

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

(d) Provide the journal entries to record the transactions in respect of the investment in 12
MaxShow Holdings Ltd from the date of acquisition to the date of disposal in the
accounting records of The Wife Ltd.

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

Please note:

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

MJM
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QUESTION 1 – Suggested solution

(a) Recognition and measurement of expected credit losses

Recognition

The Wife is required to recognise a loss allowance for expected credit losses on
financial assets measured at amortised costs (IFRS 9.5.5.1). (1)

The investment in listed bonds is classified as a financial asset measured at amortised

cost since it is held within a business model whose objective is to collect contractual
cash flows of interest and the principal amount (IFRS 9.4.1.2). (1)

At each reporting date, The Wife should assess whether the credit risk of listed bonds
increased significantly since the initial of the listed bonds (IFRS 9.5.5.9). (1)

This assessment of the increase in credit risk determines if a loss allowance equal to
an amount of lifetime expected credit losses or 12-month expected credit losses is
recognised on the listed bonds (IFRS 9.5.5.3 and IFRS 9.5.5.5). (1½)

An entity may assume that the credit risk on a financial instrument has not increased
significantly if the financial instrument is determined to have a low risk at reporting date
(IFRS 9.5.5.10). (½)

The actuary indicated that the listed bonds had a low risk on 28 February 20.22. For (½)
this reason, The Wife may assume that the credit risk on the listed bonds did not
increase significantly since the initial recognition of the listed bonds (½)

Based on the above, a loss allowance for expected credit losses equal to 12-month
expected credit losses should be recognised on the investment in listed bonds. (1)

Measurement

In terms of IFRS 9.5.17 The Wife should measure the expected credit losses on the
bonds in a way that reflects:

• An unbiased and probability-weighted amount that is determined by evaluating a

range of possible outcomes. (½)

Even though the actuary determined that there is a very low possibility of a credit
loss occurring on the listed bonds, the risk or probability that a credit loss may
occur still has to be considered. (1)

The actuary used a probability weighted amount when calculating the expected
cash flows of the listed bonds. (½)

• The time value of money. (½)

The actuary used the contract term of the listed bonds to determine the present
value of the expected contractual cash flows. (½)

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• Reasonable and supportive information that was available to actuary of The Wife
without undue cost or effort about past events, current conditions and forecasts of
future economic conditions. (1)

• The loss allowance for expected credit losses on the listed bonds are determined as
follows:
R
Present value of contractual cash flows on 28 February 20.22 920 520 (½)
Present value of expected cash flows on 28 February 20.22 899 320 (½)
Lifetime expected credit losses 21 200

Loss allowance equal to 12-month expected credit losses

(21 200 x 0,5%) 106 (1)
Total (13)
Maximum (10)

(b) Classification of the non-redeemable preference shares in the financial statements of

The Wife Ltd

• When preference shares are non-redeemable the classification in terms of IAS 32,
is based on other rights attached to the preference shares (IAS 32.AG26). (1)

• It is therefore essential to determine the substance of the contract. (1)

• The distributions to the preference shareholder determine if the preference shares

are an equity instrument or a financial liability (IAS 32.AG26). (1)

• The preference dividends on the preference shares are within the discretion of
The Wife Ltd. (1)

• Therefore, the preference shares represent an equity instrument (IAS 32.AG26) as

there is no obligation to pay dividends (deliver cash) (IAS 32.17). (1)
Total (5)

(c) Journal

Dr Cr
R R
1 September 20.21
J1 Bank (SFP) [C1] 2 850 000 (1)
Equity component of compound instrument (SCE)
[C1] 74 799 (1)
Financial liability at amortised cost (debenture)
(SFP) [C1] 2 775 201 (2½)
J2 Financial liability at amortised cost (debenture) (SFP)
[C2] 34 081 (1)
Equity component of compound instrument (SCE) [C2] 919 (1)
Bank (SFP) [C2] 35 000 (½)

MJM
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Dr Cr
R R
28 February 20.22
J3 Interest expense (P/L) [C3] [C4] 157 357 (3)
Financial liability at amortised cost: debenture (SFP) 37 357 (½)
Bank (SFP) (3 000 000 x 8% x 6/12) 120 000 (1½)
(12)

CALCULATIONS

C1. Present value of the debenture and equity component

N = 6 [½]
PMT = 120 000 (3 000 000 x 8% x 6/12) [½]
I = 5,5% (11% x 6/ 12) [½]
FV = 3 000 000 [½]
PV = 2 775 201
[2]

Proceeds on issue (3 000 000 x 95%) 2 850 000 [½]

Less PV of liability 2 775 201
Equity component 74 799 [½]

C2. Allocation of transaction costs (IAS 32.38)

Allocated to the liability component (35 000 x 2 775 201/2 850 000) 34 081 [½]
Allocated to the equity component (35 000 x 74 799/2 850 000) 919 [½]
35 000
[1]

C3. New effective interest rate after capitalisation of transaction costs (IAS 39.9)

N = 6
PMT = 120 000
FV = 3 000 000
PV = 2 741 120 (2 775 201 – 34 081) [1]
I = 11,48121% [½]
[1½]

(d) Journal entries

Dr Cr
R R
1 June 20.20
J1 Financial asset at fair value through OCI (SFP) 8 622 500 (1)
Bank (SFP) (8 500 000 + 122 500) 8 622 500 (1½)
28 February 20.21
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 (1)
31 August 20.21

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Dr Cr
R R
J3 Financial asset at fair value through OCI (SFP)
(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 (1)
J5 Mark-to-market reserve (SCE) (177 500 + 700 000) 877 500 (1)
Retained earnings (SCE) 877 500 (1)
Total (12)

MJM
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QUESTION 2 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

IGNORE ALL TAX AND VAT IMPLICATIONS

You are a chartered accountant that is trusted at your firm. You have been seconded by the
Managing Partner to assist Zile Holdings Ltd (ZH) with the financial statements for the year ended
28 February 20.21, as ZH’s financial manager does not have much knowledge of financial
instruments. ZH is in the business of supplying and servicing health care equipment across South
Africa and its head office is in the Eastern Cape, South Africa. With the Covid-19 pandemic requiring
urgent health care equipment to be provided, the company has been performing well.

The company’s strategy is to expand into other countries within Africa. When reviewing the work
performed by the financial manager, you noticed that the following transactions were only partly
accounted for, or not accounted for at all, and that it requires your attention:

(a) Bonds

ZH acquired 10 000 R130 bonds from CNL Holdings on 1 March 20.20 at a discount of 5% of
its fair value. The face value of the bond is R1 300 000. The bonds mature on 28 February
20.25 and will be redeemed at their face value. The coupon interest rate on the bonds is 10%
per annum, paid annually in arrears on 28 February.

On 1 March 20.20 the bonds were not credit-impaired and credit risk was considered to be low.
The 12-month expected credit loss was R15 000 on 01 March 20.20 and R16 500 on
28 February 20.21. The market rate of similar instruments is 13%. Transaction costs incurred
amounted to R25 000.

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

(b) Trade receivables

ZH had trade receivables that amounted to R13 300 000 as at year end. The trade receivables
do not have a significant financing component. On enquiry with the financial manager, you
discovered that the company determined the 12 months expected credit losses amounted to
R230 000 and that the lifetime expected credit loss amounted to R750 000. The financial
manager recognised the 12 months expected credit losses and the lifetime expected credit
losses in determining the final amount of receivables at year end.

(c) Convertible debentures

ZH has been receiving a lot of orders from the neighbouring African countries and as a result
the board resolved to open a branch in Botswana. After assessing the capital and operational
costs associated with this expansion, the company issued 5 400 debentures with a nominal
amount of R12 000 000 at a fair value of R2 000 per debenture on 1 March 20.20. Quarterly
interest payments of R210 000 are payable in arrears from the first quarter ending on

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31 May 20.20 and the debentures will mature on 28 February 20.24. The contract stipulated
that each debenture is convertible at the option of the debenture holder into 30 ordinary shares
for every four debentures held. Should the conversion option not be exercised, the debentures
will be redeemed at their nominal amount.

ZH incurred and paid transaction costs of R920 000 on 1 March 20.20. A market related
interest rate on 1 March 20.20, for similar debentures without conversion rights, is 13% per
annum, paid quarterly in arrears.

(d) Ordinary shares

On 01 March 20.20 ZH had share capital of R5 000 000, and on the 18th of January 20.21 ZH
issued an additional 10 000 ordinary shares to CNL Holdings at a fair value of R100 each.

ZH incurred the following costs when issuing the ordinary shares:

• The agent that was handling the transaction charged a brokerage fee of R23 000.
• The advisor involved in the transaction charged R10 500.

MJM
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QUESTION 2

YOU HAVE 60 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks
(a) Prepare all the journal entries to account for the bonds in the financial records of 15
Zile Holdings Ltd for the year ended 28 February 20.21.

Please note:
• Journal narrations are not required.
• Journals should be dated.
• Ignore all tax implications.

(b) Discuss, with reasons, any concerns you may have in relation to the recognition of 5
expected credit losses for trade receivables in the annual financial statements of
Zile Holdings Ltd for the year ended 28 February 20.21.

(c) Discuss, with reasons and calculations, the accounting treatment of the debentures 9
of Zile Holdings Ltd at 1 March 20.20 (only initial recognition and measurement).

Communication skills: clarity of expression 1

(d) Prepare an extract of the equity and liabilities in the statement of financial position of 9
Zile Holdings Ltd as at 28 February 20.21.

Communication skills: presentation and layout 1

Please note:
• Comparatives are not required.
• Ignore retained earnings and tax implications.

Please note:

• Your answer should comply with International Financial Reporting Standards (IFRS).
• Round off all amounts to the nearest rand and effective interest rate to two decimals.

MJM
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QUESTION 2 – Suggested solution

(a) Bonds
Dr Cr
R R
1 March 20.20
J1 Financial asset: Bonds at amortised cost (SFP) 1 187 828 (3)
(1 162 828 [C1] +25 000)
Bank (SFP) (25 000 + 1 104 687 [C1]) 1 129 687 (1)
Day one gain (P/L) (1 104 687 – 1162 828) 58 141 (2)
Recognition of purchase of bonds
J2 Expected credit losses (P/L) 15 000 (1)
Allowance of credit losses (SFP) 15 000 (1)
Recognise expected credit losses at initial acquisition
of financial asset
28 February 20.21
J3 Financial asset: Bonds at amortised cost (SFP) 17 510 (1)
(balancing)
Interest income (P/L) [C1.1] 147 510 (3)
Bank (SFP) 130 000 (1)
Recognise effective interest income
J4 Expected credit losses (P/L) (16 500 -15 000) 1 500 (1)
Allowance of credit losses (SFP) 1 500 (1)
Remeasurement of expected credit losses at year end
Total (15)

(b) Receivables

Since the financial asset is a trade receivable and does not contain a significant
financing component, the expected credit losses may be accounted using the simplified
approach (IFRS 9.5.5.15). (1)

Therefore, ZH has an option to adopt a policy of a lifetime expected credit loss. If ZH

has adopted a policy of lifetime expected credit loss, a reliable provision matrix needs to
be determined for the portfolio of trade receivables (IFRS B5.5.35). (2)

Using the provision matrix, a loss allowance equal to the lifetime expected credit losses
on the portfolio of trade receivables should be calculated based on the default rates per
ageing category of trade receivables (IFRS 9.5.5.15 and B5.5.35). (2)

Based on the above requirements, the 12 months expected credit losses of R230 000 (1)
should not be recognised
Therefore, only R750 000 lifetime expected credit losses should be recognised. (1)
Available (7)
Maximum (5)

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(c) Convertible debentures

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 ZH). (2)

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). (1)

Therefore, financial liability comprising the interest and capital element constitute a
financial liability in the books of ZH. (1)

The financial liability will be recognised at its fair value of R9 781 616 [C2]. (3)

The difference between the proceeds of R10 800 000 and the financial liability
component is R9 781 616 [C2] and represents the equity component of R1 018 384
[C2]. (1)

ZH incurred transaction costs of R920 000. The transaction costs should be allocated
between the equity and the financial liability components. (1)

Therefore, an amount of R833 249[C2] is capitalised against the liability component

and an amount of R86 751 [C2] is capitalised against the equity component. (2)
Available (11)
Maximum (9)
Communication skills: clarity of expression (1)

(d) ZILE HOLDINGS LTD

EXTRACT OF STATEMENT OF FINANCIAL POSITION AS AT 28 FEBRUARY 20.21

R
Equity and liabilities
Equity component of convertible debentures (1 018 384 – 86 751) 931 633 (2)
Share capital (5 000 000 + 1 000 000 (100 x 10 000) – 23 500 – 10 000) 5 966 500 (4)

Non-current liabilities
Financial liability [C2.3] 9 545 254 (1)

Current liabilities
Allowance of expected credit losses (750 000 +16 500) 766 500 (2)
Total (9)
Communication skills: presentation and layout (1)

MJM
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CALCULATIONS

C1. Present value of financial asset at amortised cost: bonds

N = 5 [½]
I = 13% [½]
PMT = 130 000 (10 000 x 130 x 10%) [½]
FV = 1 300 000 [½]
PV = -1 162 828
[2]

Discounted amount (1 162 828 x 95%) 1 104 687 [1]

C1.1 Effective interest rate after transaction cost

PV = 1 187 828 (1 162 828 + 25 000) [1]

N = 5
PMT = 130 000
FV = 1 300 000
I = 12,42%
1 Amort interest 147
[1] 510

C2. Convertible debentures

Calculation of present value of liability component

N = 16 (4 x 4) [½]
I = 3,25% (market interest rate) (13%/4) [½]
PMT = 210 000 [½]
FV = 12 000 000 [½]
PV = 9 781 616
Financial liability (PV of interest and principal amount) 9 781 616
Equity component (balancing figure) 1 018 384
Proceeds of the debenture issue (5 400 x 2 000) 10 800 000

C2.1 Allocation of transaction cost

Liability: 9 781 616/10 800 000 x 920 000 833 249 [1]
Equity: (920 000 – 833 249) (balancing) 86 751 [1]
920 000

C2.2 Effective interest rate on liability after transaction costs were capitalised

N = 16
PV = -8 948 367 (9 781 616 – 833 249) [1]
PMT = 210 000
FV = 12 000 000
I = 3,92%

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C2.3 Amortisation table for liability

Gross Effective Gross

carrying interest carrying
fixed at Interest
amount amount
3,92% coupon
opening closing
balance quarterly balance
28 February 20.21 8 948 367 1 436 887 (840 000) 9 545 254 [1]
[210 000 x 4]
28 February 20.22 9 545 254 1 536 114 (840 000) 10 241 368 [1]

MJM
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QUESTION 3 40 marks

YOU HAVE 15 MINUTES TO READ THIS QUESTION

IGNORE ALL TAX AND VAT IMPLICATIONS

You are a recently qualified chartered accountant. Due to the illness of the current financial
manager, the chief financial officer of Zwonke Wonke Ltd (ZW) requires your assistance with the
finalisation of the financial statements for the year ended 29 February 20.20. 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 their 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 on

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 regard to the investment:

Dr Cr
R R
1 March 20.18
J1 Investment in debentures (SFP) (12 000 x 35) 420 000
Transaction costs (P/L) 10 000
Bank (SFP) 430 000
Recognition of investment and transaction costs
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 considered.

MJM
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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
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%. ZW does not recognise
interest expense separately.

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QUESTION 3

YOU 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 3 – 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

earnings market for credit
loss
a35 111 4.29 a34 600
Opening balance 000 000 554 735 375 (4)
2
Profit for the period 19 118 236 (4)

Equity instrument
Fair value adjustment
(1 000 000 x (2,85 - 2,50)) 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 (1½)

Debentures
4.2(11
Fair value adjustment 124) (2½)
Derecognition
(3 633 + 25 799) x 3 000/12 000 (505) 505 (3)

Credit loss (105 000 – 34 600) 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(1
Dividends declared 060 000) (4)

29 750 000 28 932 466 638 756 105 000

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) 56 735 [½]
11 554 735

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) 58 236 [½]
19 118 236
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 = 504 000 (12 000 x 42) [½]
I = 13,1943% per annum

Amortisation table for financial asset at amortised cost: bonds

Gross Effective Gross

carrying interest carrying
fixed at Interest
amount amount
13,1943% oupon
opening closing
balance p.a. balance
28 February 20.19 430 000 56 735 (45 360) 441 375
28 February 20.20 441 375 58 236 (45 360) 454 251

Alternative
20.19: 1 Amort interest = 56 735 [½]
20.20: 2 Amort interest = 58 236 [½]

C4.2 Fair value adjustment

20.19: 36 x 12 000 = 432 000 – 441 375 (430 000 + 56 735 – 45 360) = 9 375 [2½]
20.20: 38 x 12 000 = 456 000 – 444 876 (432 000 + 58 236 – 45 360) = (11 124) [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, recognise 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 of 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 4 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
finalising 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. Transaction 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 from Lanto is available 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 on the scale, for credit evaluation purposes.

Trade receivables result from transactions that are 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 do 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 considered 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 4

YOU 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 4 – 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 of IFRS 9 Financial instruments.

Since Lanto’s trade receivables result 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 (simplified
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 receivables 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 reflect a
significant increase in credit risk is not relevant in this case, since the simplified approach
election means that Lanto in any case recognises 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
acquire 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 of 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 recognise 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 became a party to the contract on that date. (1)

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Lanto will initially recognise the option at its 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 5 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.

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 was 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 on 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 considering 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 20.10 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 the 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 were 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.
• The 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 do 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 5

YOU 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 5 – 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]

MJM
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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 the discussion below 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 to
(i) receive cash or another financial asset from another entity, or
(ii) exchange financial assets or liabilities with another entity under
conditions that are potentially favourable to the entity.

• There is a contractual right since 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 1 February 20.18. Airplane Financing only

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

MJM
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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 principal 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 cash-
flows. (1)

• The contractual terms of the loan specify that the interest is payable on
specific dates, namely on an annual basis on 31 January and the principal
amount is payable in five 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, therefore, 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 of the disclosure note on trade and other receivables

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 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)

MJM
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• To explain the changes in the loss allowance and the reasons for those changes,
Airplane Financing Ltd must provide a reconciliation by class of financial
instrument, 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 asset
(b) how forward-looking information has been incorporated into the (½)
determination of expected credit losses, including the use of
macroeconomics information
(c) changes in the estimation techniques or significant assumptions made (½)
during the reporting period and he reasons for those changes
(½)

• 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 (½)
(c) any changes in the estimation technique or significant assumptions and the
reasons for those changes (½)
Total (6)
Maximum (4)

MJM