(8) Financial Instruments. Financial Liabilities vs. Equity Instruments

Transcription

1 Financial Accounting - Module 2 (8) Financial Instruments 71 Financial Liabilities vs. Equity Instruments financial liabilities are a contractual obligation to deliver cash or another financial asset to another party in the future equity instruments shows evidence of a residual interest in the assets of the corporation once all liabilities have been settled 72 1 CMA Ontario, of 16

2 Financial Accounting - Module 2 Convertible Bonds convertible bonds are compound financial instruments because they have both the attributes of debt (obligation to deliver cash) and equity (right to acquire shares) accounting for convertible bonds is done using the residual approach: value the bond component and allocate difference to the equity component 73 Convertible bonds - Journal Entries at issue: dr. Cash cr. Bonds Payable cr. Contributed Surplus - Conversion Rights on conversion (book value method): Dr. Bonds Payable Dr. Contributed Surplus - Conversion Rights Cr. Common Shares 74 2 CMA Ontario, of 16

3 Financial Accounting - Module 2 Convertible Bonds Example On December 31, 20x2, you issue $25,000,000 of 7.5%, 20 year convertible bonds for total proceeds of $23,678,950. Interest payment dates are June 30 and Dec 31. Prepare journal entries 1. To record the issuance of bonds assuming bonds of similar risk are yielding 8.2%. 2. On July 2, 20x11, 60% of the bond issue is converted into common shares. 3. On December 31, 20x22 the remaining bonds are retired. 75 Debt with Detachable Stock Warrants bonds issued with detachable stock warrants as a means to induce the sale of the bonds warrants have the same features as a stock option: they allow the holder to purchase stock at a pre-specified price (the exercise price) split using the residual approach (residual gets allocated to the warrants) - under both IFRS and ASPE any value attached to the warrants get credited to Contributed Surplus - Warrants on exercise, we debit cash, debit Contributed Surplus and credit Common Stock (note that the market value of the common shares at the time of exercise is not relevant) 76 3 CMA Ontario, of 16

4 Financial Accounting - Module 2 Detachable Warrant Example The Harrison Corporation issued $20,000,000 of 15 year, 8% bonds on December 31, 20x2 for total proceeds of $20,000,000. Each $1,000 bond came with 5 detachable warrants allowing the holder to purchase one share of the corporation within the next 5 years at a price of $20. The yield to maturity on debt with similar maturity and risk is 8.4%. Prepare the journal entry to record the issue of the bonds. 77 Perpetual Debt no residual ownership interest, plus the value of a long-term bond is mostly derived from the PV of the coupon payments classified as a financial liability 78 4 CMA Ontario, of 16

5 Financial Accounting - Module 2 Redeemable/Convertible Preferred Shares if preferred shares are redeemable at the option of either the company or the holder, they are classified as a financial liability because of the contractual obligation to deliver cash in the future if classified as debt, then dividends are treated as interest expense convertible preferred shares: the proceeds are split between Preferred Shares and Contributed Surplus using the incremental approach 79 Hedge Accounting hedge accounting is optional to qualify for hedge accounting, designation as such must be noted at the inception of the hedging relationship, must be carefully documented and on an ongoing basis, the effectiveness of the hedge must be monitored and measured if hedge accounting is not opted for, any FX gains/losses between the time the forward contract is taken out and the transaction date flow to the income statement 80 5 CMA Ontario, of 16

6 Financial Accounting - Module 2 Fair Value Hedges using a derivative instrument to hedge the exposure to a financial asset or liability both the changes in the fair value of the financial asset and liability and derivative instrument flow to the income statement even if the financial asset is classified as an FVTOCI 81 Fair Value Hedge Example On October 31, 20x4 you purchase 1,000 shares of the Putnam Corporation for $25 per share (classified as FVTOCI). On the same day you purchase a put option contract to sell 1,000 shares of the Putnam Corporation at an exercise price of $25. The cost of the contract is $500 (the premium). On December 31, 20x4, the stock is trading for $20. The value of the put contract has increased by 1,000 shares x (25-20) = $5, CMA Ontario, of 16

7 Financial Accounting - Module 2 Cash Flow Hedges hedging a future cash flow stream with a derivative instrument example: variable interest payments hedged by entering into an interest rate swap agreement the cash settlement on the hedge offsets the hedged expense/revenue any change in value of the derivative gets recorded on the balance sheet; offset goes to OCI 83 Cash Flow Hedges - Example On December 31, 20x2, you issue 20 year bonds with a face value of $30,000,000 the LIBOR rate + 1% The LIBOR at December 31, 20x2 is 6.5%. In order to hedge any future interest rate fluctuations, you enter into a 20 year interest rate swap agreement with a third party whereby you agree to pay a fixed amount of interest of 7.5% on a notional value of $30,000,000. In exchange, you will receive a variable rate of interest equal to LIBOR + 1%. Assume interest is paid annually. At December 31, 20x3, the LIBOR rate dropped to 5% CMA Ontario, of 16

8 Financial Accounting - Module 2 ASPE Differences compound financial instruments that include both a debt and equity component - the entity may opt to measure the equity component at zero value hedge accounting is limited to: hedges of an anticipated purchase or sale of a commodity or an anticipated transaction in a foreign currency, interest rate or cross-currency rate swaps, or hedges of net investments in a self-sustaining foreign operation 85 8 CMA Ontario, of 16

9 Problem 11 Investments On January 1, 20x2, Pantry Ltd. purchased 70% of the common shares of Santry Ltd. for $506,100. Financial data for Santry Ltd. are as follows: Santry Ltd. Statement of Financial Position January 1, 20x2 Book value Fair market value Cash $ 56,000 $56,000 Accounts receivable 102, ,000 Inventory 197, ,000 Capital assets 1,250, ,000 Accumulated depreciation (500,000) $1,105,000 Current liabilities $ 140, ,000 Bonds payable at 12% interest 240, ,000 Common shares 375,000 Retained earnings 350,000 $1,105,000 Additional Information: 1. The capital assets are being written off over 10 years on a straight-line basis. 2 Goodwill is tested annually for impairment. Impairment losses are as follows: 20x4 $30,000 20x5 20, The bonds have ten years remaining. 4. During 20x5, Pantry declared and paid $50,000 of dividends. Santry declared and paid $40,000 of dividends. CMA Ontario, of 16

10 Financial statements of Pantry Ltd. and Santry Ltd. as at December 31, 20x5 are: Statement of Financial Positions December 31, 20x5 Pantry Ltd Santry Ltd Cash $ 145,500 $ 85,000 Accounts receivable 300, ,000 Inventory 609, ,000 Capital assets net 1,000, ,000 Investment in subsidiary (cost) 506,100 $2,561,100 $1,485,000 Current liabilities $ 100,000 $ 131,000 Bonds payable at 12% interest 264,000 Common shares 400, ,000 Retained earnings 2,061, ,000 $2,561,100 $1,485,000 Income Statements Year Ended December 31, 20x5 Pantry Ltd Santry Ltd Sales and other revenues $ 1,200,000 $ 925,000 Cost of goods sold (800,000) (500,000) Depreciation (80,000) (70,000) Interest expense (42,000) Other expenses (107,000) (80,000) Income tax expense (85,200) (69,900) Net income $ 127,800 $ 163,100 Required: 1. Prepare a consolidated statement of income and retained earnings for the year ended December 31, 20x5. 2. Provide a proof of the ending Consolidated Retained balance. 3. Prepare the consolidated Statement of Financial Position as at December 31, 20x5. 4. Provide a reconciliation of the NonControlling Interest Liability account from the opening balance to the ending balance. CMA Ontario, of 16

11 Problem 14 Foreign Currency Transactions The Charlie Company purchased inventory from a U.S. company on April 30, 20x8, for $US80,000. The amount is payable on July 31, 20x8, in US dollars. Charlie Company has a June 30 th year-end. The relevant exchange rates are as follows: April 30, 20x8 June 30, 20x8 July 31, 20x8 $US 1.00 = $C1.47 $US 1.00 = $C1.45 $US 1.00 = $C1.51 Required: Prepare the journal entries to account for the above transactions. CMA Ontario, of 16

12 Problem 16 Foreign Currency Transactions On August 1, 20x4, Zip Ltd. Purchased some merchandise from a company in Switzerland for SF450,000. The liability was not due until March 1, 20x5. Zip was quite confident that the exchange rate fluctuations were not a problem and took no action to hedge the liability. On November 1, 20x4, Zip looked at the exchange rates and decided that they had better offset the liability with a 120-day forward contract. Assume a December 31 year end and that all months have 30 days. EXCHANGE RATES August 1, 20x4 spot rate C$1 = SF2.5 November 1, 20x4 spot rate C$1 = SF2.1 November l, 20x4 120-day forward rate C$1 = SF1.9 December 31, 20x4 spot rate C$1 = SF1.7 December 31, 20x4 60-day forward rate C$1 = SF1.6 Aug 1 Dec 31, 20x4 average rate C$1 = SF2.0 March 1, 20x5 spot rate C$1 = SF2.7 December 31, 20x5 spot rate C$1 = SF2.9 March 1, 20x6 spot rate C$1 = SF2.4 Required: 1. Prepare all the journal entries for the years 20x4 and 20x5 for Zip for this transaction. 2. Assume that the liability was a note due on March 1, 20x6 (instead of 20x5, as given above), and that Zip does not offset with a forward contract. Prepare all the journal entries for the year 20x4. Assume that the interest in the note is 10%. CMA Ontario, of 16

13 Problem 19 Foreign Currency Translation Cancorp Ltd. purchased 90% of the shares of Forsub Inc. on January 1, 20x1. Forsub is located in the country of Amandaland. The financial statements of Forsub as at December 31, 20x2 are as follows: Forsub Statement of Financial Position as at December 31, 20x2 CORBINS Cash 150,000 Accounts receivable 175,000 Inventory 650,000 Fixed Assets 1,480,000 Accumulated depreciation (520,000) 1,935,000 Current liabilities 125,000 Long-term liabilities, 8% 300,000 Common shares 100,000 Retained earnings, January 1, 20x2 1,350,000 Net income - 20x2 100,000 Dividends (declared and paid on December 31, 20x2) (40,000) 1,935,000 Forsub Income Statement for the year ended December 31, 20x2 Sales 700,000 Cost of goods sold (450,000) Depreciation (70,000) Interest expense (28,000) Other (72,000) Gain on sale of fixed assets 20,000 Net income 100,000 Additional Information - 1. The inventory is on a FIFO basis. The opening inventory was 175,000 CORB at 1 CORB = $0.700 and 200,000 CORB at 1 CORB = $ The purchases during 20x2 were 350,000 CORB at 1 CORB = $0.686, 240,000 CORB at 1 CORB = $0.660 and 135,000 CORB at 1 CORB = $ CMA Ontario, of 16

14 2. The fixed asset account is composed of land, 345,000 CORB which was purchased when the exchange rate was 1 CORB = $0.449 and buildings and equipment, 1,135,000 CORB purchased when the exchange rate was 1 CORB = $ There have been no fixed asset acquisitions since January 1, 20x1. 3. The long-term liabilities were issued on January 1, 20x1. On July 1, 20x2 the longterm debt was reduced by 100,000 CORB. On April 1, 20x2, fixed assets were sold for proceeds of 40,000 CORB. Exchange rates are as follows: January 1, 20x1 1 CORB = $0.625 July 1, 20x1 =Average for 20x1 1 CORB = $0.673 December 31, 20x1 1 CORB = $0.745 April 1, 20x2 1 CORB = $0.725 July 1, 20x2 = Average for 20x2 1 CORB = $0.686 Average for Jan-Jun 20x2 1 CORB = $0.700 Average for Jul- Dec 20x2 1 CORB = $0.670 December 31, 20x2 1 CORB = $0.660 Part (A) Prepare a translated income statement assuming that Forsub s functional currency is te Canadian dollar. Part (B) Use the same data as in Part (A), but assume that Forsub s functional currency is the CORB. Forsub earned 250,000 CORB in 20x1 and declared and paid dividends of 100,000 CORB on December 31, 20x1. Calculate the balance in the Cumulative translation gain/loss account. CMA Ontario, of 16

15 Problem 20 Foreign Currency Transactions On September 1, 20x5 you order a machine from a Swiss supplier. The cost of the machine is SF1,000,000. The machine is received on November 30, 30x5. You pay the invoice on March 31, 20x6. Your year-end is December 31. The following rates are available: Required Spot Sep 1, 20x5 1SF = $0.75 Nov 30, 20x5 1SF = $0.86 Dec 31, 20x5 1SF = $0.92 Mar 31, 20x6 1SF = $1.02 Forward Sep 1 (7 months) 1SF = $0.82 Oct 31 (5 months) 1SF = $0.90 Nov 30 (4 months) 1SF = $0.97 Dec 31 (3 months) 1SF = $0.99 Prepare all journal entries for the above transactions assuming that a. no forward contract is taken out to offset the payable. b. a forward contract is taken out to offset the payable on November 30, the day the goods are received. CMA Ontario, of 16

16 Accelerated Program Week 11 Work Plan Suggested study plan for this week: Primary List Secondary List 1. Review what we did in class on Saturday. 2. Financial Instruments Problem 1, 2, 3, 4 CMA Ontario, of 16