Solution to Q 1 (Answers to the question on IFRS 9)

On 1 June 20X4

IFRS 9

The entries in the books of Kredco will be:

DEBIT Trade receivables $200,000
CREDIT Revenue $200,000

Being initial recognition of sales

An expected credit loss allowance, based on the matrix above, would be calculated as follows:
DEBIT Expected credit losses $2,000
CREDIT Allowance for receivables $2,000
Being expected credit loss: $200,000 × 1%

In accordance with IAS 39, allowance for receivable shall not be recognized, unless there is objective evidence that
the receivable has been impaired.

On 31 July 20X4
IFRS 9
Applying Kredco’s matrix, Detco has moved into the 5% bracket, because it has exhausted its 60-day
credit limit. (Note that this does not equate to being 60 days overdue!) Despite assurances that Kredco will receive
payment, the company should still increase its credit loss allowance to reflect the increased credit risk. Kredco will
therefore record the following entries on 31 July 20X4.

DEBIT Expected credit losses $8,000

CREDIT Allowance for receivables $8,000
Being expected credit loss: $200,000 × 5% – $2,000

DEBIT Bad debt expense $10,000

CREDIT Allowance for receivables $10,000

Solution to Q 2
Answer
Expected default
rate Gross carrying
amount Credit loss allowance
Default rate × gross
carrying amount
$’000 $’000
Current 0.5% 32,000 160
1 to 30 days overdue 1.8% 16,000 288
31 to 60 days overdue 3.8% 10,000 380
61 to 90 days overdue 7% 7,000 490
More than 90 days overdue 11% 3,000 330
68,000 1,648

The credit loss allowance has increased by $488,000 to $1,648,000 as at 30 June 20X5. The journal entry at 30 June
20X5 would be:

DEBIT Expected credit losses $488,000

CREDIT Allowance for receivables $488,000
Being expected credit loss
Solution to Q 3
(i)
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (EXTRACT)
$m
Profit or loss for the year
Investment income (10m × (6.5 – 5.0)) 15
Dividend income (10m × 20c) 2
Transaction costs (3)

STATEMENT OF FINANCIAL POSITION (EXTRACT)

Investments in equity instruments (10m × 6.5) 65

(ii)
STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (EXTRACT)
$m
Profit or loss for the year
Dividend income 2

Other comprehensive income

Gain on investment in equity instruments 15

STATEMENT OF FINANCIAL POSITION (EXTRACT)

Investments in equity instruments
((10m × 6.5) + 3m) 68

Solution to Q 4
(i) Convertible bond
Some financial instruments have both a liability and an equity component. In this case, IAS 32 Financial
Instruments: Presentation requires that the component parts be accounted for and presented separately
according to their substance. The split is made on the issue date.

A convertible bond contains two components:

– the issuer’s contractual obligation to pay cash in the form of interest or capital
– the contract to issue a fixed number of equity shares.

The liability component will be determined by discounting the future cash flows. The discount rate used
will be 9%, which is the market rate for similar bonds without the conversion right. The difference between
cash received and the liability component is the value of the equity.
$m
Present value of cash flows
Year 1 (31 May 20X7) ($100m × 6%) ÷ 1.09 5.50
Year 2 (31 May 20X8) ($100m × 6%) ÷ 1.092 5.05
Year 3 (31 May 20X9) ($100m + ($100m × 6%)) ÷ 1.093 81.85
––––––
Total liability component 92.40
Total equity element 7.60
––––––
Proceeds of issue 100.0
The entries required to account for this are:

Dr Cash $100m
Cr Liability $92.40m
Cr Equity $7.60m

The issue cost will have to be allocated between the liability and equity. The entries required are:

Dr Liability $0.92m
Dr Equity $0.08m
Cr Cash $1.00m
After posting the above entries, the liability and equity would have carrying amounts as follows:
$m $m
Liability Equity
Proceeds 92.40 7.60
Issue cost (0.92) (0.08)
–––––– ––––––
91.48 7.52
–––––– ––––––

The equity of $7.52 million will not be re-measured.

The liability component of $91.48 million would be measured at amortised cost. This means that interest is
charged at the effective rate of 9.38%. The cash payments reduce the liability.

Interest
1 June X6 (9.38%) Cash paid 31 May X7
(6% × $100m)
$m $m $m $m
91.48 8.58 (6.0) 94.06

The finance cost in profit or loss will be $8.58 million. The liability will have a carrying amount on 31 May
20X7 of $94.06 million.

(ii) Shares in Smart

The entries required are:

Dr Financial asset (shares in Given) $5.5m
Cr Financial asset (shares in Smart) $5.0m
Cr Other Comprehensive Income $0.5m

(iii) Investment in bonds

Financial assets are initially measured at fair value, so the investment in the bond will be initially recognised
at $10 million.

The entity’s business model involves both holding debt instruments to collect their contractual cash flows
and also selling the assets. As a debt instrument, it would appear that the contractual terms of the asset
comprise the repayment of the principal and interest on the principal amount outstanding. Therefore, the
asset should be measured at fair value through other comprehensive income.
Interest income should be recognised in profit or loss using the effective rate of interest. At the reporting
date, the asset should be revalued to fair value with the gain or loss recognised in other comprehensive
income. These gains or losses will be recycled to profit or loss if the asset is disposed of.

Interest income of $1.5 million (W1) should be recognised in profit or loss. Revaluing the asset to its fair
value of $9.0 million will lead to a loss of $2.0 million (W1) being recorded in other comprehensive income.

Loss allowance

IFRS 9 Financial Instruments requires a loss allowance to be recognised on investments in debt that are
measured at amortised cost or fair value through other comprehensive income.

If credit risk has not increased significantly since initial recognition, the loss allowance should be equal to
12-month expected credit losses. If credit risk has increased significantly, the loss allowance must be equal
to lifetime expected credit losses.

The credit risk of Winston’s bonds remains low at the reporting date, suggesting that there has not been a
significant increase in credit risk. The loss allowance should therefore be equal to the 12-month expected
credit losses of $0.2 million.

When the financial asset is measured at fair value though other comprehensive income, the loss allowance
is not adjusted against the asset’s carrying amount (otherwise the asset will be held below fair value).
Therefore, the loss allowance is charged to profit or loss, with the credit entry being recorded in other
comprehensive income (essentially, this adjustment reclassifies $0.2 million of the earlier downwards
revaluation from other comprehensive income to profit or loss).

Working
(W1) Financial asset

1/12/X3 Interest
(15%) Cash
received Total Loss. 30/11/X4
$m $m $m $m $m $m
10.0 1.5 (0.5) 11.0 (2.0) 9.0