AC4301 Corporate Accounting II
HKFRS 9 Financial Instruments
In-Class Assignment
Question 1 (Definition of Financial Asset)
Why do you think that physical assets and prepaid expenses do not qualify as
financial instruments?
Question 2 (Classification of Financial Instrument)
XY Ltd issues $3,000,000 7% cumulative redeemable preference shares with a fixed
maturity date. The shares are redeemable only on maturity at the option of the holder.
Required:
Determine (with reasons) whether this financial instrument should be classified as
a financial liability or equity instrument of XY Ltd.
Question 3 (Compound Financial Instrument)
On 1 January 20X1, an entity issued 100,000 6% convertible bonds at their par value of
$20 each. The bonds will be redeemed on 1 January 20X6. Each bond is convertible at
the option of the holder at any time during the five-year period. Interest on the bond
will be paid annually in arrears.
The prevailing market interest rate for similar debt without conversion options at the
date of issue was 8%.
Required:
At what value should the equity element of the hybrid financial instrument be
recognised in the financial statements of the entity at the date of issue? Further,
prepare the journal entries to record the initial recognition of the bond.
Question 4 (Compound Financial Instrument)
On 1 January 2017, City Ltd issued a $100,000 4% convertible bond for $100,000.
Market rates for similar bonds without the conversion option are 6%. The interest will
be paid on an annual basis i.e. 31 December. The fair value/ present value of the bonds
is determined as $90,000.
1
Required:
(a) Identify the equity component of the convertible bonds.
(b) Provide the journal on 1 January 2017 in respect of the issue of the bonds.
(c) Provide the journal on 31 December 2017 and 2018 in respect of the interest
payment and the adjustment for the bonds.
(d) Provide the journal on 1 January 2019 in respect of the convertible bond
being converted into ordinary shares at the rate of $2 of convertible bond for
one $1 ordinary share.
Question 5 (Financial Assets measured at Fair Value)
On 6 November 20X3 Stripe Co. acquires a listed equity investment with the intention
of holding it in the long term. The investment cost $500,000 which was paid in cash.
At Stripe Co.'s year end of 31 December 20X3, the market price of an identical
investment is $520,000. How is the asset initially and subsequently measured?
Stripe Co. has elected to present changes in the fair value of the equity investment in
other comprehensive income.
Required:
Prepare journal entries to record the financial assets for the year 20X3.
Question 6 (Measurement of Financial Assets)
On 1 July 20X1 Booker Williams (BW) acquired $40 million 5% loan stock at a cost
of $38 million. Further information is as follows:
• Interest is payable annually in arrears.
• The loan stock will be redeemed at a 5% premium on 30 June 20X4.
• The effective interest rate attached to the loan stock is 8.49%.
• The fair value of the loan stock is $38.8 million at 30 June 20X2 and $40.8
million at 30 June 20X3.
• The loan stock is held by BW within a business model whose objective is
achieved both by collecting contractual cash flows and selling financial assets.
Required:
(a) Calculate amounts to be recognised in the financial statements of BW for the
years ended 30 June 20X2 and 20X3.
(b) State the relevant journal entries in the years ended 30 June 20X2 and 30
June 20X3.
(c) State the relevant journal entries to recognise the disposal of the loan stock on
1 July 20X3 for $41 million.
2
Question 7 (Measurement of Financial Liabilities)
Grumble Co. issues a bond for $839,619 on 1 January 20X2. No interest is payable on
the bond, but it will be held to maturity and redeemed on 31 December 20X4 for
$1 million. The bond has not been designated as at fair value through profit or loss.
Required:
Calculate the charge to profit or loss of Grumble Co. for the year ended
31 December 20X2 and the balance outstanding at 31 December 20X2.
Question 8 (Credit Losses)
On 1 January 20X4 Lord Robinson (LR) acquired an investment in $600,000 8% loan
stock. The investment is measured at amortised cost.
At 1 January 20X4 there is a 6% probability that the borrower will default on the loan
during 20X4 resulting in a 100% loss.
At 31 December 20X4 there is 1% probability that the borrower will default on the loan
before 31 December 20X5 resulting in a 100% loss.
At 31 December 20X5 the borrower is expected to breach its covenants as a result of
cash flow problems. There is a 40% probability of the loan defaulting over the
remainder of its term.
At 31 December 20X6 the borrower breached its covenants and there is a 70%
probability of default over the remainder of the loan term.
Required:
What impairment loss and interest revenue are recognised at initial recognition
and in each of the years ended 31 December 20X4, 20X5 and 20X6?