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AC312 Advanced International Financial Reporting

Workshop 2 Financial Instruments 1

Questions

Question 1

Identify whether any of the following are financial instruments, and if so whether they are financial assets, financial liabilities, equity instruments or derivatives, and for which party:

a) A sells £5,000 of inventory to B on 30 day payment terms;

b) C pays £20,000 for a twelve-month insurance policy in advance;

c) D, a UK-based business, enters into a contract to sell $400,000 at a specified date in the future. Currently D does not hold any $ currency;

d) E issues 100,000 ordinary shares which are acquired by F;

e) G borrows £200,000 under a mortgage from H

Question 2

How has the principle of substance over form been implemented with respect to accounting for financial instruments?

Question 3

On 1 January 2011, an entity issued £400,000 7% bond at par. Interest is payable on 31 December each year. The bond will be redeemed on 31 December 2014 but may be converted into ordinary shares on that date instead.

(i) What type of financial instrument is reflected by this transaction and how, in principle, should it be accounted for?

(ii) Assuming that the interest rate for a similar bond without the option to convert is 9%, calculate the liability and equity component of this bond.

(iii) Show how the liability will increase over time such that it will reach £400,000 when repayment is due.

(iv) Show how the instrument will affect the Statement of Financial Position of the issuing entity for the year ending 31 December 2011 such that that Statement of financial position will balance.

PV factors are as follows:

End of year 6% 7% 8% 9%

1 0.943 0.934 0.926 0.917

2 0.890 0.873 0.857 0.842

3 0.840 0.816 0.794 0.772

4 0.792 0.763 0.735 0.708

Question 4

With respect to the subsequent measurement of financial assets for any business:

(i) What two conditions must apply for a debt instrument to be measured at amortised cost?

(ii) What change to these conditions would result in the debt instrument being measured at fair value through other comprehensive income?

(iii) How are equity instruments to be measured?

(iv) How are derivatives measured?

(v) How useful is the above to the user?

Question 5

A plc makes a loan of £600,000 to B Ltd on 1 January 2011. Interest of 3% per annum is due annually in arrears. B Ltd must repay £738,000 on 31 December 2015. This gives an effective interest of 7% per annum. A plc usually makes such loans with the intention of holding until repayment date.

(i) What type of financial instrument is reflected by this transaction and how should it be accounted for by A plc and B Ltd.?

(ii) Calculate the amounts at which the loan to B Ltd would be measured at in A plc’s Statement of financial position for the years ended 31 December 2011 to 31 December 2015 and the interest income that would be recognised in the Statement of profit or loss for those financial years.

(iii) How would the loan affect B Ltd.’s accounts, for the years ended 31 December 2011 to 31 December 2015? 

(iv) Show how the instrument will affect the Statement of financial position of A plc for the year ending 31 December 2011. In so doing show how that Statement of financial position will balance.