Financial Assets - Initial Measurement 5 / 12

Question 3a

One of the issues covered by IFRS 9 Financial Instruments (revised July 2014) is the classification and measurement of financial assets. The three possible measurement bases identified by the standard are:
 – Amortised cost.
 – Fair value through other comprehensive income.
 – Fair value through profit or loss.

Required:
Explain how IFRS 9 requires entities to select the appropriate measurement basis for a financial asset. You should include any options available to entities regarding classification in your explanation.

Note: You are NOT required to define a financial asset. (7 marks)

Question 3b

(b) Epsilon prepares financial statements to 31 March each year. The following events have occurred which are relevant to the year ended 31 March 2018:

(i) On 1 April 2017, Epsilon loaned $30 million to another entity. Interest of $1·5 million is payable annually in arrears. An additional final payment of $35·3 million is due on 31 March 2020. Epsilon incurred direct costs of $250,000 in arranging this loan. The annual rate of interest implicit in this arrangement is approximately 10%. Epsilon has no intention of assigning this loan to a third party at any time. (4 marks)

(ii) On 1 April 2017, Epsilon purchased 500,000 shares in a key supplier – entity X. The shares were purchased in order to protect Epsilon’s source of supply and Epsilon has no intention of trading in these shares. The shares cost $2 per share and the direct costs of purchasing the shares were $100,000. On 1 January 2018, the supplier paid a dividend of 30 cents per share. On 31 March 2018, the fair value of a share in entity X was $2·25. (5 marks)

(iii) On 1 January 2018, Epsilon purchased 100,000 call options to purchase shares in entity Y – an unconnected third party. Each option allowed Epsilon to purchase shares in entity Y on 31 December 2018 for $6 per share. Epsilon paid $1·25 per option on 1 January 2018. On 31 March 2018, the fair value of a share in entity Y was $8 and the fair value of a share option purchased by Epsilon was $1·60. This purchase of call options is not part of a hedging arrangement. (4 marks)

Required:
Explain and show how the three events should be reported in the financial statements of Epsilon for the year ended 31 March 2018. In part (b) you should assume that Epsilon only measures financial assets at fair value through profit or loss when required to do so by IFRS 9.

Note: The mark allocation is shown against each of the three events above.

Question 4a

You are the financial controller of Omega, a listed entity which prepares consolidated financial statements in accordance with International Financial Reporting Standards (IFRS). You have recently prepared the financial statements for the year ended 30 September 2017 and these are due to be published shortly. The managing director has reviewed these financial statements and has prepared a list of queries arising out of the review.

Query One
I’m confused about our treatment of equity investments in listed entities that we don’t control. There seem to be two different treatments in our financial statements. One of the notes to the financial statements says that the equity investments we hold to temporarily invest surplus cash balances are measured at fair value and that changes in fair value are recognised in profit or loss. Another note says that the equity investment we hold in a key supplier is measured at fair value and that changes in fair value are recognised in other comprehensive income (OCI). Earnings per share (EPS) is a key performance indicator for Omega, so please explain how it can be justified to use two different treatments for equity investments made by the same entity. Please also explain what the impact on EPS might be if a gain or loss is reported in OCI rather than profit or loss. (6 marks)

Required: 
Provide answers to the queries raised by the managing director. You should justify your answers with reference to relevant International Financial Reporting Standards.

Note: The mark allocation is shown against each of the four queries above.

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Question 3a

(a) One of the matters addressed in IFRS 9 – Financial Instruments is the initial and subsequent measurement of financial assets. IFRS 9 requires that financial assets are initially measured at their fair value at the date of initial recognition. However, subsequent measurement of financial assets depends on their classification for which IFRS 9 identifies three possible alternatives.

Required:
Explain the three classifications which IFRS 9 identifies for financial assets and the basis of measurement which is appropriate for each classification. You should also identify any exceptions to the normal classifications which may apply in specific circumstances. (8 marks)

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Question 3b i

(b) Kappa prepares financial statements to 30 September each year. During the year ended 30 September 2016 Kappa entered into the following transactions:

(i) On 1 October 2015, Kappa made an interest free loan to an employee of $800,000. The loan is due for repayment on 30 September 2017 and Kappa is confident that the employee will repay the loan. Kappa would normally require an annual rate of return of 10% on business loans (5 marks)

Required:
Explain and show how the above transactions would be reported in the financial statements of Kappa for the year ended 30 September 2016.

Note: The mark allocation for part (b) is shown against each of the three transactions above.

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Question 3b iii

(b) Kappa prepares financial statements to 30 September each year. During the year ended 30 September 2016 Kappa entered into the following transactions:

(iii) On 1 October 2015, Kappa purchased an equity investment in entity Y for $12 million. The investment did not give Kappa control or significant influence over entity Y but the investment is seen as a long-term one. On 30 September 2016, the fair value of Kappa’s investment in entity Y was estimated to be $13 million. (3 marks)

Required:
Explain and show how the above transactions would be reported in the financial statements of Kappa for the year ended 30 September 2016.

Note: The mark allocation for part (b) is shown against each of the three transactions above.

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Question 2a

Delta is an entity which prepares financial statements to 31 March each year. The financial statements for the year ended 31 March 2015 are to be authorised for issue on 30 June 2015. The following events are relevant to these financial statements:

(a) On 1 April 2014, Delta purchased 1 million options to acquire shares in Epsilon, a listed entity. Delta paid 25c per option, which allows Delta to purchase shares in Epsilon for a price of $2 per share. The exercise date for the options was 31 December 2014. On 31 December 2014, when the market value of a share in Epsilon was $2·60, Delta exercised all its options to acquire shares in Epsilon. In addition to the purchase price, Delta incurred directly attributable acquisition costs of $100,000 on the purchase of the 1 million shares in Epsilon. Delta regarded the shares it purchased in Epsilon as part of its trading portfolio. However, Delta did not dispose of any of the shares in Epsilon between 31 December 2014 and 31 March 2015. On 31 March 2015, the market value of a share in Epsilon was $2·90. (9 marks)

Required:
Explain and show how the three events should be reported in the financial statements of Delta for the year ended 31 March 2015.

Note: The mark allocation is shown against each of the three events above.

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Question 2a

Delta is an entity which prepares financial statements to 30 September each year. Each year the financial statements are authorised for issue on 30 November. During the year ended 30 September 2013 the following transactions occurred:

(a) On 1 April 2013, Delta subscribed for 40 million $1 loan notes in Epsilon. The loan notes were issued at 90 cents and under the terms of issue were redeemable at $1·20 on 31 March 2018. Interest is payable on 31 March in arrears at 4% of par value. This represents an effective annual rate of return for Delta of 9·9%. Delta’s intention is to hold the loan notes until redemption. Until 31 October 2013 Epsilon was a successful company with a good reputation for settling all its liabilities on their due dates. However, due to an event which occurred on 31 October 2013, three of Epsilon’s major customers became insolvent and this caused liquidity problems for Epsilon. During November 2013 Epsilon entered into negotiations with all its creditors, including Delta. Delta agreed to forego the interest payments due on 31 March 2014 and 2015, with the payments from 31 March 2016 onwards resuming as normal. (8 marks)

Required:
Explain and show (where possible by quantifying amounts) how the three events would be reported in the financial statements of Delta for the year ended 30 September 2013. You do not need to quantify amounts which are only shown in the notes to the financial statements.

Note: The mark allocation is shown against each of the three events above.
You should assume that all transactions described here are material.

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