Part 1 (Ex59 – SBR 2024)
The directors of Aron would like advice about the financial reporting treatment of some
financial instrument transactions that took place during the year ended 31 May 20X7.
Convertible bonds:
Aron issued one million convertible bonds on 1 June 20X6. The bonds had a term of
three years and were issued for their fair value of $100 million, which is also the par
value. Interest is paid annually in arrears at a rate of 6% per annum. Bonds without the
conversion option attracted an interest rate of 9% per annum on 1 June 20X6. The
company incurred issue costs of $1 million. The impact of the issue costs is to increase
the effective interest rate to 9.38%. At 31 May 20X9 the bondholders can opt to be
repaid the par value in cash, or they can opt to receive a fixed number of ordinary shares
in Aron.
Share exchange: Aron held 3% holding of the shares in Smart, a public limited
company. The investment was designated upon recognition as fair value through other
comprehensive income and as at 31 May 20X7 was measured at its fair value of $5
million. The cumulative gain reported in other comprehensive income and held in equity
relating to this investment was $400,000. On 31 May 20X7, the whole of the share
capital of Smart was acquired by Given, a public limited company. Aron received shares
in Given with a fair value of $5.5 million in exchange for its holding in Smart.
Winston bonds
On 1 June 20X6, Aron purchased $10 million of listed bonds at par and paid in cash.
These bonds had been issued by Winston, an entity operating in the video games
industry. The bonds are due to be redeemed at a premium on 31 May 20X9, with Aron
also receiving 5% interest annually in arrears. The effective rate of interest on the bonds
is 15%. Aron often holds bonds until the redemption date, but will sell prior to maturity
if investments with higher returns become available. Winston's bonds were deemed to
have a low credit risk at inception. On 31 May 20X7, Aron received the interest due on
the bonds. However, there were wider concerns about the economic performance and
financial stability of the video games industry. As a result, the quoted price of Aron's
investment at 31 May 20X7 was $9 million, although a pricing model developed by the
financial controller that relies on management estimates valued the holding at $9.5
million. Based on Winston's strong working capital management and market optimism
about the entity's forthcoming products, the bonds were still deemed to have a low credit
risk.
The financial controller of Aron calculated the following expected credit losses for the
Winston bonds as at 31 May 20X7:
+ 12 month expected credit losses: $0.2m
+ Lifetime expected credit losses: $0.4m
Required:
a. Discuss the accounting treatment of the convertible bonds in the financial
statements for the year ended 31 May 20X7.
b. Discuss the accounting treatment of the share exchange in the financial
statements for the year ended 31 May 20X7.
c. Discuss the accounting treatment of the Winston bonds in the financial statements
for the year ended 31 May 20X7. Your answer should explain the impact of the
bonds in Aron's statement of cash flows.
Part 2: (Ex60.b – SBR 2024)
On 1 July 20X6, Klancet purchased a debt instrument for its nominal value of $5 million.
The transaction was at fair value. Klancet's business model is to hold financial assets to
collect the contractual cash flows but also sell financial assets if investments with higher
returns become available. Interest is received at a rate of 4% annually in arrears. The
effective rate of interest is 10%.
On 30 June 20X7, the fair value of the debt instrument was $4.5 million. There has not
been a significant increase in credit risk since inception. Expected credit losses are
immaterial.
The directors are unsure how to account for this financial instrument. They also wish to
know if the correct accounting treatment is consistent with the Conceptual Framework.
Required:
Discuss, with reference to IFRS 9 Financial Instruments, how the above transactions
should be dealt with in Klancet's financial statements for the year ended 30 June 20X7.
