21 Financial Instruments s22 - FINAL

GAAP: Graded Questions Financial instruments – general principles
Solution 21.1
Part A
a) False.
There are certain aspects of the definition that are missing:
A financial asset is defined as:

• Cash;
• An equity instrument of another entity;
• A contractual right to receive cash or another financial asset from another entity, or to
exchange financial assets or financial liabilities with another entity under condition that
are potentially favourable to the entity;
• A contract that will be settled in the entity’s own equity instruments which is a non-
derivative for which the entity is or may be obliged to receive a variable number of the
entity’s own equity instruments or which is a derivative which will or may be settled other
than by the exchange of a fixed amount of cash or another financial asset for a fixed
number of the entity’s own equity instruments. IAS 32.11
b) False.
A prepaid expense is not cash, not an investment in an equity instrument, not a contract that
will be settled in the entity’s own equity instruments. Instead, a prepaid expense is a
contractual right. However, this does not make it a financial asset because the future economic
benefit expected from this contractual right is the receipt of goods or services, and not cash
or another financial asset. Thus, prepaid expenses are not financial assets. See IAS 32.AG11
c) False.
IFRS 9.5.1.1 provides that at initial recognition, an entity shall measure a financial asset at is
fair value.
The fair value of a financial asset is normally the acquisition (transaction) price (the fair value
of consideration given or received).
However, where the transaction price and fair value differ, the treatment is as follows:
• Where part of the consideration given or received is for something other than the financial
asset, the excess of the transaction price over the fair value is an expense or reduction of
income, unless it qualifies for recognition as an asset.
• Where consideration given or received is only in respect of the financial asset, the
treatment is dependent on the level of inputs used in determining the fair value of the
financial instrument: if the fair value is determined by the quoted price in an active market
for an identical asset or based on a valuation technique that uses only data from
observable markets (Level 1 or Level 2 input), the difference between the fair value and
transaction price is recognised on initial recognition as a gain or loss.
• If the fair value is determined by use of a Level 3 input, the difference between the fair
value and transaction price is deferred and shall be recognised as a gain or loss only to
the extent that it arises from a change in a factor that market participants would take into
account when pricing the asset or liability. See IFRS 9B5.1.2A & IFRS 13
© Service & Kolitz, 2022-2023 Chapter 21: Page 1

Solution 21.1 continued...

Part A continued...
d) False.
IFRS 9.4.1.2 provides that a financial asset shall be measured at amortised cost only if the
following conditions are both met:
• The financial asset is held within a business model whose objective is to hold financial
assets in order to collect contractual cash flows, and
• The contractual terms of the financial asset give rise, on specified dates, to cash flows
that are solely payments of principal and interest on the principal amount outstanding.
Interest consists of consideration for the time value of money, credit risk and other basic
lending risks and costs. See IFRS 9.4.1.3
If an entity holds debentures which are convertible into the equity instruments of the issuer,
the interest rate reflects consideration for the time value of money, credit risk and the value
of the equity of the issuer. Thus, as the return is linked to the value of the issuer’s equity,
contractual coupon payments are not solely payments of the principal and interest on the
principal amount outstanding.
Conclusion: Investments in convertible debentures will always be classified at fair value

through profit or loss.
Note: An entity cannot make an irrevocable election to classify these debentures at fair value
through other comprehensive income in terms of IFRS 9.4.1.4, as this paragraph relates solely
to equity instruments. As debentures are debt instruments, the provisions of this paragraph are
not applicable.
e) False.
Initial recognition and initial measurement:
Investments in equity and debt instruments at fair value through other comprehensive income
are measured at fair value on initial recognition. See IFRS 9.5.1.1
Subsequent measurement:
The fair value gain/loss on equity instruments at fair value through other comprehensive
income is recognised in other comprehensive income. See IFRS 9.5.7.1
Debt instruments at fair value through other comprehensive income are measured on a basis
that combines the amortised cost and fair value model. This is as IFRS 9.5.7.11 requires that
the amounts recognised in profit or loss are the same as the amounts that would have been
recognised in profit or loss if the financial asset had been measured at amortised cost.
This means that an amortisation table will be prepared ignoring the fair value of the financial
asset after initial recognition. Interest expense will be recognised in profit or loss based on the
effective interest rate method. At the end of each financial reporting period, the fair value
adjustment recognised in other comprehensive income will be calculated as follows:
FV – Amortised cost of the debt instrument – FV adjustment processed in prior periods.
f) False.
Lease receivables (for both financial and operating leases) recognised by a lessor are subject
to the derecognition and impairment requirements of IFRS 9 Financial instruments. Thus,
these paragraphs need to be considered when accounting for lease receivables recognised in
terms of IFRS 16 Leases. See IFRS 9.2.1(b)(i) and IFRS 16.77

Part B
a) False.
There are certain aspects of the definition that are missing (unfavourable exchanges and
certain derivative contracts). See the underlined section below.
A financial liability is defined as:

• a contractual obligation:
- to deliver cash or another financial asset to another entity, or
- to exchange financial assets or financial liabilities with another entity under
conditions potentially unfavourable to the entity; or
• a contract that will or may be settled in the entity’s own equity instruments and is:
- a non-derivative for which the entity is or may be obliged to deliver a variable number
of the entity’s own equity instruments; or
- a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity’s own equity
instruments. IAS 32.11
b) False.
In terms of the definition of a financial liability, the contract being settled by the issue of a
fixed number of an entity’s own equity instruments would need to be a derivative contract
to be a financial liability. Thus, this situation would not necessarily mean the obligation is
a ‘financial liability’. See IAS 32.11
c) False.
In the case of a financial liability, the transaction costs are only expensed if the financial
liability is classified as fair value through profit or loss. See IFRS 9.5.1.1
d) False.
In the case of financial liabilities that are not involved in hedging, the foreign exchange gains
or loss are always expensed. See IFRS 9.B5.7.2 & IAS 21

Part C
a) False
The process of identifying whether an asset is required to be impaired is a requirement of IAS

36 Impairment of assets. However, financial assets are scoped out of the IAS 36 requirements
and, instead, the requirements for impairing a financial asset are contained in IFRS 9 Financial
instruments. See IAS 36.2(e)
Unlike IAS 36, the impairment model of IFRS 9 requires impairments to be processed
regardless of whether or not there is an indication of impairment at reporting date. This is
because the expected credit loss model contained in IFRS 9 is a forward-looking model, that
requires an entity to consider the likelihood of a financial asset being impaired over its lifetime
(or, in special circumstances, over 12 months). Thus, an entity would have to record an
impairment loss, even if there was no indication of impairment at reporting date. See IFRS 9.5
b) False
According to IFRS 9.5.5, a loss allowance is only recognised for expected credit losses on
financial assets classified as amortised cost and fair value through other comprehensive income –
debt. For assets subsequently classified at fair value through profit or loss, the impairment loss is
incorporated into the fair value adjustment, as the market will have already included the expected
credit losses into the fair value of the asset. See IFRS 9.5.2.2
Note: the fair value of assets measured through other comprehensive income would also
reflect any loss allowances. However, as the collection of contractual cash flows is still
integral to the business model of such an asset, IFRS 9 requires that the financial asset adjust
profit or loss in the same way as if it were measured at amortised cost (i.e. it should recognise
a loss allowance before accounting for a fair value adjustment. See IFRS 9.5.7.11
c) False
According to IFRS 9.5.5, it is no longer necessary for a credit event to have occurred before
credit losses are recognised. An entity must account for expected credit losses. The amount
of credit losses needs to be updated at each reporting date to reflect changes in these expected
credit losses.
Thus, an entity must consider, not only what has occurred during the year, but what it expects
to occur in the future (either over the lifetime of the asset, or for the next 12 months, depending
on which approach is used, and whether the asset is considered to be credit impaired.
d) False
If a trade receivable has a significant financing component, and is held for longer than one
year, an entity may elect to use the general approach to impair the receivable. See IFRS 9.5.5.15

Part D
a) False
A financial asset shall only be reclassified when an entity changes its business model for managing
financial assets. A change in an entity’s business model only occurs when an entity either begins
or ceases to perform an activity that is significant to its operations, for example, when the entity
acquires, disposes or terminates a business line. Thus, a change in management’s intention is
insufficient to result in the reclassification of a financial asset where it is not accompanied by a
significant change to an entity’s operations. See IFRS 9.4.4.1 & .B4.4.1
b) False.
A decision to classify a financial asset at FVOCI-equity on initial recognition is an irrevocable

decision. Thus, an entity is unable to reclassify the asset after initial recognition. See IFRS 9.4.1.4
c) False
IFRS 9 Appendix A defines the reclassification date as “the first day of the first reporting
period following the change in business model that results in an entity reclassifying financial
assets”. Thus, a change in business model is always affected before the reclassification date.
d) False
Financial liabilities may never be reclassified.

Solution 21.2
Classification and initial measurement of the 5 investments
Classification of the 5 investments:
Investment in equity instruments
General theory relating to the classification of equity instruments
An investment in equity instruments does not render any contractual cash flows. Thus, the SPPI
criterion is not met, as it would not be possible to conclude that it produces contractual cash
flows that are solely a return of principal plus interest on principal.
Since an investment in equity instruments would fail the SPPI test, it fails one of the 2 criteria
to be classified at amortised cost, listed in IFRS 9.4.1.2. Similarly, it also fails one of the 2
criteria to be classified at fair value through other comprehensive income – debt instrument, in
terms of IFRS 9.4.1.2A. Thus, the investment would typically be classified at fair value through
profit or loss (IFRS 9.4.1.4).
However, because the investment involves equity instruments, Jabulani may, on initial
recognition, irrevocably elect to classify the investment at fair value through other
comprehensive income – equity instrument, in terms of IFRS 9.4.1.4 & IFRS 9.5.7.5. This latter
classification may only be used if the investment is:
• Not held for trading; and is
• Not contingent consideration recognised by an acquirer in a business combination to which
IFRS 3 applies. See IFRS 9.5.7.5
This theory is now applied to the three investments involving equity instruments.
The investment in unlisted shares
We are not given sufficient information to be sure that the investment is not held for trading
and is not contingent consideration recognised by an acquirer in a business combination.
If the investment is not held for trading and is not contingent consideration, it means that
Jabulani could classify the investment either at:
• Fair value through profit or loss
• Fair value through other comprehensive income – equity instruments.
However, if the investment is held for trading or is contingent consideration, Jabulani would
have to classify the investment at fair value through profit or loss.
The initial measurement of this investment, based on the two possibilities, is explained further
in the solution under the heading that refers to the ‘initial measurement of the 5 investments’.
The investment in listed shares
We are told that the investment in the listed shares are traded and thus the option to classify this
investment in equity instruments at fair value through other comprehensive income is not
available. Thus, this investment must be classified at:
• Fair value through profit or loss.
The initial measurement of this investment is explained further in the solution under the heading
that refers to the ‘initial measurement of the 5 investments’.

Solution 21.2 continued …
The investment in shares in subsidiary companies
We are not given sufficient information to be sure that the investment is not held for trading
and is not contingent consideration recognised by an acquirer in a business combination.
However, if these criteria are met (i.e. the investment is not held for trading and is not contingent
consideration), it means that Jabulani could classify the investment either at:
• Fair value through profit or loss
• Fair value through other comprehensive income – equity instruments.
However, if the investment is held for trading or is contingent consideration, then Jabulani
would be forced to classify the investment at fair value through profit or loss.
Note: The above would apply in Jabulani’s separate financial statements but IFRS 3 would
need to be applied if and when drafting consolidated financial statements.
The initial measurement of this investment, based on the two possibilities, is presented under
the heading ‘Initial measurement of the 5 investments’.
Investment in debt instruments
General theory relating to the classification of debt instruments
If a debt instrument renders contractual cash flows that represent solely the return of principal
plus interest on the principal (i.e. if the SPPI criteria is satisfied), then we would need to
consider the objective of the business model applied by Jabulani in managing the investment
(discussed below). However, if either the debt instrument does not render contractual cash
flows and/or these contractual cash flows do not represent solely the return of principal plus
interest on principal (i.e. the SPPI criteria is not satisfied), then the investment is classified at
fair value through profit or loss.
If the SPPI criterion is satisfied, we must consider the objective of the business model in
managing that investment.
• If the business model objective is to hold the investment to collect contractual cash flows
until maturity (held to collect), then the investment must be classified at amortised cost
(AC).
• If the business model objective is to hold the investment to collect contractual cash flows
and to sell the asset (held to collect and sell), then the investment must be classified at fair
value through other comprehensive income (FVOCI-debt).
• If the business model objective is to trade the investment (held to sell), then the investment
must be classified at fair value through profit or loss (FVPL).
However, if the criteria indicate that the investment must be classified at amortised cost or at
fair value through other comprehensive income, Jabulani still has the option to classify the
investment at fair value through profit or loss in the event that the classifications that have been
indicated to be used would result in an accounting mismatch.
This theory is now applied to the three investments involving debt instruments.

The investment in government bonds
The investment in government bonds render contractual cash flows that represent a return of
principal and interest on the principal (i.e. the SPPI criterion is met). Since the business model
is to hold to maturity (i.e. held to collect), this investment must be classified at amortised cost.
Note: We are not given any evidence that there would be an accounting mismatch if the
investment is classified at amortised cost and thus the option to classify at fair value through
profit or loss has not been explored.
The initial measurement of this investment is presented under the heading ‘Initial measurement
of the 5 investments’.
Investment in convertible debentures
The investment in convertible debentures cannot be said to render contractual cash flows that
represent a return of principal plus interest on principal, because the principal is not guaranteed
to be repaid in cash – the principal could be repaid in shares instead (i.e. the SPPI criterion is
not met). Since the SPPI criterion is not met, the investment must be classified at fair value
through profit or loss (P.S. If the SPPI criterion is not met, there is an alternative option to
classify the asset at fair value through other comprehensive income, but this only applies if the
investment is an equity instrument and is not held for trading – since this investment is not an
investment in equity instruments, this alternative option is not relevant See IFRS 9.4.1.4).
Investment in corporate bonds
The investment in corporate bonds render contractual cash flows that represent a return of
principal and interest on principal (i.e. the SPPI criterion is met). Since the business model is
to hold the corporate bonds for trading purposes (i.e. held to sell), neither the amortised cost
classification nor the fair value through other comprehensive income classification are
appropriate. Thus, this investment must be classified at fair value through profit or loss instead.
Initial measurement of financial assets:
General theory relating to the initial measurement of financial assets
The initial measurement of financial assets is always at fair value, but whether transaction costs
are capitalised or expensed depends on their classification (summarised as follows):
Classification Initial measurement:

Fair value through profit or loss Fair value *
Fair value through other comprehensive income (debt or equity) Fair value + transaction costs
Amortised cost Fair value + transaction costs
* in the case of FVPL, any transaction costs would be expensed

The fair value on initial recognition is normally the acquisition price. However, if the acquisition
price does not equal the fair value, the financial asset must still be initially measured at fair
value. The difference between the acquisition price and the fair value would result in the
recognition of a day-one gain or loss. There is no evidence given that the acquisition costs did
not equal the respective fair values of the investments and thus this possibility is not discussed
further (i.e. we assume that each investment’s acquisition cost reflected its fair value).
The initial measurement of financial assets may also involve the initial recognition of a loss
allowance for expected credit losses, depending on the classification (it only applies to financial
assets classified at amortised cost and financial assets classified at fair value through other
comprehensive income – debt instruments). However, this question instructs us to ignore
expected credit losses and thus the expected credit loss allowance is not discussed further.
Application of the theory relating to the initial measurement to the 5 financial assets
The application of this theory to the initial measurement of each of the 5 investments is
presented below.
Investment Classification Calculations/ comments Initial

measurement
Unlisted shares Two options possible:
• FVPL At FV (transaction costs expensed) C2 640 000
• FVOCI-E FV: 2 640 000 + Transaction costs: 33 C2 673 000
000
Listed shares FVPL At FV (transaction costs expensed) C2 112 000

2 137 520, incl transaction costs –
25 520
Shares in subsidiary Two options possible:

• FVPL At FV (transaction costs expensed) C16 830 000
• FVOCI-E FV: 16 830 000 + Transaction costs: C18 616 400
1 786 400
Government bonds AC FV: 1 144 000 + Transaction costs: 16 1 160 500

500
Convertible debentures FVPL At FV (transaction costs expensed) C4 928 000
Corporate bonds FVPL At FV (transaction costs expensed) C6 877 200
Legend:
FVPL = fair value through profit or loss
FVOCI – E = fair value through other comprehensive income – equity instruments
FVOCI – D = fair value through other comprehensive income – debt instruments
AC = amortised cost

Solution 21.3
a) Discussion
All financial assets are initially measured at fair value. Whether or not to also capitalise the
transaction costs to the asset will depend on its classification. The subsequent measurement of
financial assets is either at amortised cost or at fair value. Deciding how to subsequently
measure the financial assets depends on the classification thereof.
Financial assets can be classified as at:

• Amortised cost;
• Fair value through profit or loss;
• Fair value through other comprehensive income – debt instruments; and
• Fair value through other comprehensive income – equity instruments. See IFRS9.5.2.1 & IFRS9.5.7.5
The classification is determined based on two criteria:

• The contractual cash flow characteristics of the financial asset; and
• The business model for managing the financial assets. See IFRS 9.4.1.1
If the financial asset’s contractual cash flow characteristics do not involve solely the return of
the principal amount and interest on the principal, then the financial asset must be classified at
fair value through profit or loss, unless it is an equity instrument for which the entity may make
an irrevocable election on initial recognition to present subsequent fair value changes in other
comprehensive income. See IFRS 9.5.7.5
However, if the financial asset’s contractual cash flow characteristics do involve solely the
return of the principal amount and interest on the principal, then the financial asset may be
classified either at amortised cost or fair value. Which classification is appropriate depends on
an assessment of the business model used to manage the financial asset.
In this regard, management must assess whether the entity is holding the asset for the purpose
of receiving contractual cash flows until maturity (hold to collect) or whether the assets are held
to collect contractual cash flows and to sell the asset (hold to collect and sell). P.S. If the asset
is held to sell, it is classified at fair value through profit or loss.
The financial asset is classified as an amortised cost financial asset if:

• the cash flows represent solely the return of principal and interest on the principal; and
• the objective of the business model for managing the asset is to collect the contractual cash
flows until maturity (hold to collect). NOTE 1
The financial asset is classified as a financial asset at fair value through other comprehensive
income (debt instruments) if:
• the cash flows represent solely the return of principal and interest on principal; and
• the objective of the business model for managing the asset is to collect the contractual cash
flows and to sell the asset (hold to collect and sell). NOTE 1
NOTE 1: Even if the criteria for amortised cost or fair value through other comprehensive
income are met, management still has the ability (on initial recognition) to designate the asset
at fair value through profit or loss if it will remedy some accounting mismatch. See IFRS 9.4.1.5

a) continued …
Portfolio 1: Government bonds
The bonds involve the receiving of contractual cash flows that represent solely the return of the
principal plus interest on the principal. We thus need to consider the business models applied
to the portfolio.
We are told that the objective of the business model used to manage the first portfolio
(government bonds) is met by simply collecting contractual cash flows and thus this portfolio
is classified at amortised cost.
The first portfolio, classified as amortised cost, will be measured as follows:

• initially measured at fair value (generally its cost), with transaction costs capitalised;
• subsequently measured using the effective interest rate method. See IFRS 9.5.1.1 & IFRS 9.5.4.1
The interest on the effective interest rate method will be recognised in profit or loss.
Portfolio 2: Equity Instruments
Equity instruments result in exposure to variable returns, that is, Spirit Limited does not receive
contractual cash flows – dividends are received subject to a declaration by the issuing entity.
Thus, equity instruments will be classified as subsequently measured at fair value through profit
or loss, unless the irrevocable election to classify the instruments as subsequently measured at
fair value through other comprehensive income is applied at initial recognition. See IFRS 9.5.7.5
IFRS 9.5.7.5 provides that this election is available provided that the equity instrument is
neither held for trading or contingent consideration recognised by an acquirer in a business
combination to which IFRS 3 applies. As Spirit Limited has indicated that they would prefer to
reflect the fair value movements of the equity instruments in other comprehensive income, it is
assumed that Spirit Limited would elect IFRS 9.5.7.5 as the equity instruments are not held for
trading and no indication is given that it is held as contingent consideration.
The second portfolio, classified as fair value through other comprehensive income, will be
measured as follows:
• initially at fair value (generally its cost), with transaction costs capitalised;
• subsequently measured to its fair values at the end of each reporting date. See IFRS 9.5.2.1
Movements in fair value are recognised in other comprehensive income.
There is no evidence of an accounting mismatch in either portfolio and thus the option to
irrevocably designate the portfolios at initial recognition at fair value through profit or loss is
not available.
Only Portfolio 1 would typically be subject to tests for impairment with a loss allowance for
credit losses recognised when the government bonds are initially recognised. However, the
question indicates that credit losses should be ignored. See IFRS 9.5.5.1

b) Journals:
31 December 20X7 Debit Credit

Bank Given 45 000
Financial asset: Amortised cost (A) Balancing 13 583
Interest income (P/L) W1 58 583
First portfolio is classified as a financial asset at amortised cost:
Recognition of interest for the year ended on amortised financial
asset using the effective interest rate method
Bank 900 000

Financial asset: Amortised cost (A) W1 900 000
Redemption of government bonds
Financial asset: Fair value (A) FV at end of year: 1 320 000 – 120 000
Gain on financial asset (OCI) FV at beginning of year: 1 200 120 000
000
Second portfolio is classified as a financial asset at fair value: the
entity elected on initial recognition to recognise the FV movements
in other comprehensive income instead of in profit or loss
Bank 144 000

Dividend income (P/L) 144 000
Second portfolio is classified as a financial asset at fair value:
Dividends received during the year on investments classified at FV
are recognised in P/L (even though the entity has elected to recognise
the FV movements in OCI)
WORKINGS:
W1: Effective interest rate table:

Effective interest Interest received Balance
at 6.60895% (W2)
1 January 20X3 840 000
31 December 20X3 55 515 (45 000) 850 515
31 December 20X4 56 210 (45 000) 861 725
31 December 20X5 56 951 (45 000) 873 676
31 December 20X6 57 741 (45 000) 886 417
31 December 20X7 58 583 (45 000) 900 000
Redemption (900 000)
W2: Effective interest rate
n=5
PV = - (780 000 + 60 000) = -840 000 (remember that in the case of amortised cost instruments, the
transaction costs are capitalised)
PMT = 45 000
FV = 900 000
comp I = 6.60895%

Solution 21.4
Part A: Biscuit Limited
Journals
Debit Credit
2 January 20X4
Bank (A) 20 000 x (C1 000 – C200) 16 000 000
FL: Debentures: AC (L) 16 000 000
Issue of debentures, a financial liability, classified at amortised cost since
they were not held for trading and thus did not meet the criteria to be
classified at FVPL and were not designated at FVPL
31 December 20X4
Interest expense (P/L: E) W1 4 037 219
Interest expense at the effective interest rate of 25.23262%
FL: Debentures: AC (L) 20 000 x C1 000 x 15% 3 000 000

Bank(A) 3 000 000
Payment of coupon payment on debentures
31 December 20X5

Bank(A) 3 000 000
31 December 20X6

Bank(A) 3 000 000
31 December 20X7

Bank(A) 3 000 000

Bank(A) 22 000 000
Redemption of debentures

Part A continued …
WORKINGS:
W1: Effective interest rate table – debenture liability
Interest Interest paid at Balance

expense 15%
at 25.23262% (given)
(given)
02 January 20X4 At FV: 20 000 x C800 16 000 000
31 December 20X4 4 037 219 (3 000 000) 17 037 219
31 December 20X5 4 298 937 (3 000 000) 18 336 156
31 December 20X6 4 626 693 (3 000 000) 19 962 849
31 December 20X7 5 037 151* (3 000 000) 22 000 000
Redemption (22 000 000)
* Balancing figure
Effective interest rate calculation (for your interest):

N=4
PV = 20 000 x (C1 000 – C200) = - 16 000 000 (assumed issue price = fair value)
PMT = 20 000 x C1 000 x 15% = 3 000 000
FV = 20 000 x C100 x 110% = 22 000 000
Comp I = 25.23262%

Part B: Milk Limited
Journals
Debit Credit
2 January 20X4
FA: Debentures: AC (A) FV: 20 000 x 80% x (C1 000 – C200) + 12 832 000
Bank (A) Transaction costs: 32 000 12 832 000
Acquisition of debentures for C12 800 000, recognised as an asset and
classified at amortised cost (given), thus transaction costs capitalised
Impairment loss (P/L: E) Given 5 000

FA: Debentures: AC: LA (-A) 5 000
Recognition of loss allowance on financial asset, measured at 12 month
expected credit losses (because not credit-impaired on acquisition)
31 December 20X4
Bank (A) 20 000 x 80% x C1 000 x 15% 2 400 000
FA: Debentures: AC: (A) Balancing 825 381
Interest income (P/L: I) W1 3 225 381
Recognition of receipt of interest and the interest income on the investment
in Biscuit debentures (EIR method).
Impairment loss (P/L: E) C6 000 – C5 000 1 000

Recognition of movement in loss allowance on financial asset, measured
at 12 month expected credit losses (because not credit-impaired on
acquisition)
31 December 20X5
Bank (A) 20 000 x 80% x C1 000 x 15% 2 400 000
FA: Debentures: AC: (A) Balancing 1 032 845
FA: Debentures: AC: LA (-A) C6 000 – C4 000 2 000

Impairment loss reversal (I: P/L) 2 000
acquisition)
31 December 20X6
Bank (A) 20 000 x 80% x C1 000 x 15% 2 400 000

acquisition)
Continued on the next page

Part B continued …
Journals
Debit Credit
31 December 20X7
Bank (A) 20 000 x 80% x C1 000 x 15% 2 400 000
FA: Debentures: AC: LA (-A) C5 500 – C0 5 500

Impairment loss reversal (P/L: I) 5 500
Recognition of loss reversal on financial asset, measured at 12 month
expected credit losses (because not credit-impaired on acquisition)
Bank (A) Given 17 600 000

FA: Debentures: AC: LA (-A) 17 600 000
Receipt of principal payment from investment in debentures in Biscuit
Limited
Note:
• The loss allowance was first accounted for on initial recognition of the financial asset.
• At each subsequent reporting date, the movement in the expected credit loss is recognised as an
expense, or income, depending on the total expected credit loss at that date.
• The 12-month expected credit losses have been used as the loss allowance at each subsequent
reporting date, as the credit risk remained low, and did not significantly increase for the duration of
the investment.
WORKINGS:
W1: Effective interest rate table – debenture asset
Interest income Interest received at Balance

at 25.135453% 15%
(W2) (given)
02 January 20X4 13 832 000
31 December 20X4 3 225 381 (2 400 000) 13 657 381
31 December 20X5 3 432 845 (2 400 000) 14 690 226
31 December 20X6 3 692 455 (2 400 000) 15 982 681
31 December 20X7 4 017 319 (2 400 000) 17 600 000
Redemption (17 600 000)
W2: Effective interest rate
N=4
PV = – 20 000 x 80% x (C1 000 – C200) – 32 000 = –12 832 000
PMT = 20 000 x 80% x C1 000 x 15% = 2 400 000
FV = 20 000 x 80% x C1 000 x 110% = 17 600 000
Comp I = 25.135453%

Solution 21.5
Investment in shares
Fair value through profit or loss Debit Credit

The shares are held as long-term investment which may indicate that Flighty is not holding them for
trade. However, shares do not have contractual cash flows since the amount and timing of dividend
payments are decided on by the issuer (Tiny). Dividends are also not a return of capital and interest
since the purchase of shares are not repayable.
The investment must therefore be measured at fair value. The management had the opportunity to
designate this investment as fair value through other comprehensive income on initial recognition, but
there is no evidence of this, therefore the solution assumes the assets are measured at fair value through
profit or loss.
1 January 20X9
FA: Investment in shares (A) Given 240 000
Bank (A) 240 000
Purchase of shares
Investment transaction costs expense (E: P/L) 2 400
Bank (A) 2 400
Costs incurred in purchase of shares expensed FVPL
30 June 20X9
FA: Investment in shares (A) 270 000 – 240 000 30 000
Fair value gain (I: P/L) 30 000
Fair value adjustment
Issue of redeemable preference shares
Debit Credit
31 December 20X8
Bank (A) 1 200 000
FL: Preference share liability (L) 1 200 000
The entity does not have the unconditional right to avoid paying cash
(share price is not controlled by the entity) thus it is a liability
(IAS32)
30 June 20X9
Interest expense (dividend) (P/L: E) 1 200 000 x 10% x 6/12 60 000
Shareholders for dividends (L) 60 000
Dividend declared at year end.
Investment in redeemable debentures
Amortised cost Debit Credit

1 September 20X9
FA: Debentures (A) Given 205 800
Bank (A) 205 800
Purchase of debentures
Impairment loss (P/L: E) Given 500
FA: Debentures: AC: LA (-A) 500
Recognition of loss allowance on financial asset, measured at
12 month expected credit losses (because not credit-impaired on
acquisition)

Solution 21.5 continued ...

28 February 20X9
Bank (A) 210 000 x 11% x 6/12 11 550
FA: Debentures (A) Balancing 953
Interest income (P/L: I) 205 800 x 12,1502% x 6/12 12 503
Interest income for the 6-month period.
30 June 20X9
FA: Debentures (A) (205 800+953) x 12,1502% x 4/12 8 374
Interest income (P/L: I) 8 374
Interest at year end
Impairment loss (P/L: E) C650 – C500 150
FA: Debentures: AC: LA (-A) 150
Recognition of movement in loss allowance on financial asset,
measured at 12 month expected credit losses (because not credit-
impaired on acquisition)
Investment in futures
Futures: Fair value through profit or loss Debit Credit

The futures have contractual cash flows since the contract itself states that the futures will be settled
on a daily basis through debits or credits to the entity’s bank account. It is assumed that these cash
flows are the reason the futures were entered into, and therefore the first condition is met. The cash
flows are however not a return of principal and interest but rather a return in fluctuation in other price
factors that influence the index. The investment must therefore be measured at fair value through
profit or loss (the investment is held for speculative reasons and therefore management did not have
the option to classify it as fair value through other comprehensive income).
1 November 20X9
Margin deposit (A) 88 000
Bank (A) 88 000
Margin deposit made on futures
31 December 20X9
Bank (A) 100 x 10 x (2 430 – 2 250) 180 000
Gain on futures (I: P/L) 180 000
Futures re-measured at fair value at year-end
Investment in options
Debit Credit
There are no contractual cash out flows in the case of options but simply the right to purchase (i.e.
futures, on the other hand, represent an obligation to buy), therefore it must be classified at fair value
through profit and loss.
1 February 20X9
Financial asset: Option (A) 33 000
Bank (A) 33 000
Margin deposit on call options
30 June 20X9
FA: Option (A) 22 x (20 020 – 19 800) 4 840
Gain on call options (I: P/L) 4 840
Gain made on exercise of options
Bank (A) 37 840

FA: Option (A) 37 840
Return on exercise of options.

Solution 21.6
Part A
Journals
Debit Credit
The gilts are held in terms of a business model the objective of which is to collect contractual cash
flows. The contractual terms give rise on specified dates to cash flows that are solely payments of
principal and interest. Both criteria are met and thus the asset must be measured at amortised cost.
1 January 20X9
FA: Government gilts (A) Given 270 000
Bank (A) 270 000
Purchase of gilts
30 June 20X9
Bank (A) 300 000 x 8% x 6/12 12 000
FA: Government gilts (A) Balancing 4 297
Interest income 270 000 x 12.0718% x 6/12 16 297
Interest on government gilt and receipt of coupon payment
(amortised cost)
1 July 20X9
Bank (A) Given 170 000
FA: Government gilts (A) (270 000 + 4 297) x 60%* 164 578
Profit on sale Balancing 5 422
Sale of 60%* of the gilts
*: Face value sold / Face value purchased originally x 100/1
= 180 000 / 300 000 x 100/1 = 60%
31 December 20X9
Bank (A) 300 000 x 40% x 8% x 6/12 4 800
Interest income 274 297 x 40% x 12.0718% x 6/12 6 623
Interest to year-end on the remaining 40% of the gilts
(amortised cost)
Comment:
The market-related interest rate was given as a red-herring and must be ignored: using the effective
interest rate method means that we must use the effective interest rate, which is defined in IFRS 9
Appendix A as:
• the rate that exactly discounts
• estimated future cash payments or receipts
• through the expected life of the financial instrument
• to the gross carrying amount of the financial asset or amortised cost of a financial liability.
The market rate of 10.6% would not discount the future value of 300 000 to the present value of
274 297 (calculated as at 30 June 20X9).

Part A continued ...
WORKINGS:
These workings are for your interest only:
W1: Effective interest rate table for the government gilts from date of purchase
Interest
Dates income Receipts Balance
1 January 20X9 270 000
30 June 20X9 16 297 (12 000) * 274 297
31 December
20X9 16 556 (12 000) 278 853
30 June 20Y0 16 831 (12 000) 283 685
31 December
20Y0 17 123 (12 000) 288 807
30 June 20Y1 17 432 (12 000) 294 240
31 December
20Y1 17 760 (12 000) 300 000
102 000 (72 000)
W2: Effective interest rate table for the government gilts from date of sale of 60%
Interest
Dates income Receipts Balance
30 June 20X9 274 297 W1
30 June 20X9 60% sold (164 578)
30 June 20X9 40% remaining 109 719
31 December 20X9 6 623 (4 800) ** 111 542
30 June 20Y0 6 733 (4 800) 113 475
31 December 20Y0 6 849 (4 800) 115 524
30 June 20Y1 6 973 (4 800) 117 697
**
31 December 20Y1 7 103 (4 800) 120 000 *
102 000 (36 000)
* 300 000 x 8% x 6/12 = 12 000 receivable every 6 months
** 300 000 x 40% x 8% x 6/12 = 4 800 receivable every 6 months
*** 300 000 x 40% = 120 000 receivable on redemption

Part B
Debit Credit
The gilts are held in terms of a business model the objective of which is to collect contractual cash
flows. The contractual terms give rise on specified dates to cash flows that are solely payments of
principal and interest. Both criteria are met and thus the asset must be measured at amortised cost.
1 January 20X9
FA: Government gilts (A) Given 270 000
Bank (A) 270 000
Purchase of gilts
Impairment loss (P/L: E) 22 000

FA: Government gilts: AC: LA (-A) 22 000
Recognition of loss allowance, measured at 12-month expected
credit losses
30 June 20X9
Bank (A) 300 000 x 8% x 6/12 12 000
Interest income (P/L: I) 270 000 x 12.0718% x 6/12 16 297
Interest up to date of sale (amortised cost)
1 July 20X9
Bank (A) Given 170 000
FA: Government gilts: AC: LA (-A) 22 000 x 60% 13 200
FA: Government gilts (A) (270 000 + 4 297) x 60%* 164 578
Profit on sale (P/L: I) Balancing 18 622
Sale of 60%* of the gilts
*: Face value sold / Face value purchased originally x 100/1
= 180 000 / 300 000 x 100/1 = 60%
31 December 20X9
Bank (A) 300 000 x 40% x 8% x 6/12 4 800
Interest income (P/L: I) 274 297 x 40% x 12.0718% x 6/12 6 623
Interest to year-end on the remaining 40% of the gilts (amortised cost)
Comment:
The market-related interest rate was given as a red-herring and must be ignored: using the effective
interest rate method means that we must use the effective interest rate, which is defined in
IFRS 9 Appendix A as:
• the rate that exactly discounts
• estimated future cash payments or receipts
• through the expected life of the financial instrument
• to the gross carrying amount of the financial asset or amortised cost of a financial liability.
The market rate of 10.6% would not discount the future value of 300 000 to the present value of
274 297 (calculated as at 30 June 20X9).

Solution 21.7
Part A
Journals
Debit Credit
20X0
1 January Bond: FV through P/L (A) 2 200 x C1 188 2 613 600
Bank 2 613 600
Acquisition of bond
31 December Bank 2 200 x C1 188 x 13% 339 768
Interest income (P/L) 339 768
Receipt of coupon on bond
31 December FV loss on investment (P/L) FV: (C1 144 x 2 200) – 96 800
Bond: FV through P/L (A) CA: C2 613 600 96 800
Fair value adjustment of bond classified as FV through P/L
20X1
31 December Bond: FV through P/L (A) FV: (C1 287 x 2 200) – 314 600
CA: (C1 144 x 2 200)
FV gain on investment (P/L) 314 600
20X2
CA: (C1 287 x 2 200)
Bond: FV through P/L (A) 391 600
20X3
31 December Bond: FV through P/L (A) FV: (1 307 x 2 200) – 435 600
CA: (C1 109 x 2 200)
FV gain on investment (P/L) 435 600
Bank C1 188 x 2 200 x 1.12 2 927 232
Bond: FV through P/L (A) C1 307 x 2 200 2 875 400
FV gain on redemption (P/L) 51 832
Redemption of bonds

Part B
Journals
Debit Credit
20X0
1 January Bond: Amortised cost (A) 2 200 x C1 188 2 613 600
Bank 2 613 600
Acquisition of bond

Bond: Amortised cost (A) 62 455
20X1
31 December Bank W1 339 768
Interest income, measured at the effective interest rate
20X2
31 December Bank 1 000 x 540 x 11% 339 768
Receipt of coupon interest on bond
20X3
31 December Bank 2 927 232

Bond: Amortised cost (A) 2 927 232
Receipt of bond redemption on maturity
WORKINGS:
*PV = - 2 613 600 (C1 188 x 2 200) FV = 2 613 600 x (1+12%) = 2 927 232
PMT = 2 613 600 x 13% = 339 768 N=4
Comp I = 15,3896%
W1. Amortisation schedule based on an EIR of 15.3896*% for the remaining years to maturity
Classified as amortised cost
Dates Interest income Receipts Balance
01 January 20X0 2 613 600
31 December 20X0 402 223 (339 768) 2 676 055
31 December 20X1 411 834 (339 768) 2 748 121
31 December 20X2 422 925 (339 768) 2 831 278
31 December 20X3 435 722 (339 768) 2 927 232
1 672 704 (1 359 072)
31 December 20X3 Redemption (2 927 232) 0
(4 286 384)
Principal: 2 613 600 + Interest: 1 672 704

Part C
Journals
Debit Credit
20X0
1 January Bond: FV through P/L (A) 2 200 x C1 188 2 613 600
Bank 2 613 600
Acquisition of bond


Bond: FV through P/L (A) CA: C2 613 600 96 800
20X1
1 January Bond: Amortised cost (A) 2 516 800
Bond: FV through P/L (A) 2 516 800
Reclassification of financial asset previously classified as
‘fair value through profit or loss’ to ‘amortised cost’ (P.S.
Although the business model changed in 20X0, the
reclassification takes place on the first day of the year
following the change in business model)

20X2
20X3
31 December Bank 2 927 232

Bond: Amortised cost (A) 2 927 232
Receipt of bond redemption on maturity

Part C continued …
WORKINGS:
*PV = - 2 516 800 FV = 2 613 600 x (1+12%) = 2 927 232

PMT = 2 613 600 x 13% = 339 768 N=3
Comp i= 18,0622%
W1. Amortisation schedule based on an EIR of 18,0622*% for the remaining years to maturity
Classified as amortised cost
Dates Interest Receipts Balance
income
1 January 20X1 2 516 800
31 December 454 590 (339 768) 2 631 622
20X1
31 December 475 330 (339 768) 2 767 184
20X2
31 December 499 816 (339 768) 2 927 232
20X3
1 429 736 (1 019 304)

Part D
Debit Credit
1 January 20X0
FA: Bonds at AC (A) 2 200 x C1 188 (FV) 2 613 600
Bank (A) 2 613 600
Purchase of Bonds (assumed issue price = fair value)
Impairment loss (P/L: E) C2 613 600 x 20% x 0.5% = 2 614
FA: Bonds: AC: LA (-A) 2 613.60 (rounded) 2 614
Recognition of loss allowance, measured at 12-month expected
credit losses
31 December 20X0
Bank (A) 2 200 x C1 188 x 13% 339 768
FA: Bonds at AC (A) Balancing 62 455
Interest income (P/L) Part B W1 402 223
Interest received from bonds
Impairment loss (P/L: E) (C2 613 600 x 20% x 0.6%) – 523

FA: Bonds: AC: LA (-A) C2 613.6 = 522.72 (rounded) 523
Recognition of movement in loss allowance, measured at 12-
month expected credit losses
31 December 20X1
Bank (A) 2 200 x C1 188 x 13% 339 768
Interest income (P/L: I) Part B W1 411 834
Interest income, measured at amortised cost

FA: Bonds: AC: LA (-A) C2 613.6 – C522.7 = 261.38 261
31 December 20X2
Bank (A) 2 200 x C1 188 x 13% 339 768

FA: Bonds: AC: LA (-A) C2 613.6 – C522.7 – C261.38 = 784
784.08

Part D continued...
31 December 20X3
Bank (A) C1 118 x 2 200 x 13% 339 768
FA: Bonds: AC: LA (-A) C2 614 + C523 + C261 + C784 4 182

Impairment loss reversal (P/L: I) 4 182
Derecognition of loss allowance on the date of redemption of
bonds
Bank (A) 2 613 600 x 112% 2 927 232

Part B W1
FA: Bonds at AC (A) 2 927 232
Receipt: redemption of bonds

Solution 21.8
a) Discussion of financial assets
Introduction:
There are three possible classification options relevant to the investment in the preference
shares, (being an investment in a debt instrument):
• Amortised cost;
• Fair value through other comprehensive income; and
• Fair value through profit or loss.
Deciding which classification is appropriate to the investment in the preference shares will
require Melbourne Limited to assess:
• The objective of the business model used to manage the financial asset; and
• The contractual cash flow characteristics of the financial asset.
Amortised cost:
To classify the investment in preference shares at amortised cost, both the following criteria
must be satisfied:
• The investment must be held in terms of a business model the objective of which is to hold
it to collect the related contractual cash flows (held to collect); and
• The investment offers contractual terms that give rise to cash flows that are solely payments
of principal and interest on the principal.
In this case, the investment in the preference shares offers contractual cash flows that constitute
solely a return of principal and interest on that principal. This means that if the business model
objective is to hold the investment to collect the contractual cash flows, the investment must be
classified at amortised cost (AC), unless this classification would result in an accounting
mismatch in which case it could be classified at fair value through profit or loss (FVPL) instead
(see below).
The measurement of a financial asset classified at amortised cost is as follows:

• The asset is initially measured at fair value with directly attributable transaction costs
capitalised to the cost of the asset (this would impact on the effective interest rate).
• The asset is subsequently measured at amortised cost, which entails calculating the effective
interest rate and then using the effective interest rate method to determine the interest
income for the reporting period and the asset’s carrying amount at reporting date.
• Dividends on the preference shares are recognised when the right to receive the dividend is
established (recognised as a reduction in the carrying amount of the financial asset).
Fair value through other comprehensive income:
To classify the investment in the preference shares at fair value through other comprehensive
income, both the following criteria must be satisfied:
• The investment must be held in terms of a business model the objective of which is to hold
it to collect it contractual cash flows and to sell it (held to collect and sell); and
• The investment offers contractual terms that give rise to cash flows that are solely payments
of principal and interest on the principal.
Continued on the next page…

a) continued ...
In this case, the investment in the preference shares offers contractual cash flows that constitute
solely a return of principal and interest on that principal. This means that if the business model
objective is to hold the investment to collect the contractual cash flows and to sell the
investment, the investment must be classified at fair value through other comprehensive income
– debt (FVOCI-debt), unless this classification would result in an accounting mismatch in
which case it could be classified at fair value through profit or loss (FVPL) instead (see below).
The measurement of a financial asset classified at FVOCI-debt is as follows:

capitalised to the cost of the asset (this would impact on the effective interest rate).
• The asset is subsequently measured at amortised cost, which entails calculating the
effective interest rate and then using the effective interest rate method to determine the
interest income for the reporting period and the asset’s carrying amount at reporting date.
• Dividends on the preference shares are recognised when the right to receive the dividend is
established (as a reduction in the carrying amount of the financial asset).
• The asset is then remeasured to fair value with fair value adjustments recognised in other
comprehensive income (these fair value gains or losses recognised in OCI would be
reclassified to profit or loss on derecognition of the investment).
Fair value through profit or loss:
If either the business model test fails (i.e. the asset is held for trading) and/ or the contractual
cash flow test fails (i.e. the asset does not offer contractual cash flows, or the contractual cash
flows offered by the asset do not constitute purely a return of principal plus interest on
principal), then the investment in preference shares must be classified at fair value through
profit or loss.
Similarly, if the investment met the requirements to be classified at amortised cost or met the
requirements to be classified at fair value through other comprehensive income but these
classifications would have led to an accounting mismatch, then Melbourne Limited could elect
on initial recognition to classify the investment at fair value through profit or loss instead. This
election would be irrevocable.
In this case, the investment does offer contractual cash flows that represent solely the return of
principal plus interest on principal and thus the investment would be classified at fair value
through profit or loss if:
• It was held for trading; or
• It met the requirements to be classified at amortised cost but this classification would have
resulted in an accounting mismatch; or
• It met the requirements to be classified at FVOCI but this classification would have resulted
in an accounting mismatch.
The measurement of a financial asset classified at FVPL is as follows:

expensed.
• The preference dividends will be recognised as income, in profit or loss, when the right to
receive the dividends is established.
• The investment is remeasured to fair value at reporting date and fair value gains or losses
will be recognised in profit or loss.

b) Journals: financial asset at amortised cost
Debit Credit
1 January 20X5
FA: Violin pref shares: at AC: GCA (A) Fair value 20 328 000 + 20 328 000
Bank Transaction costs: 0 20 328 000
Purchase of Violin’s preference shares (assumed issue price = fair
value)
31 December 20X5
Dividend receivable (A) Given 2 032 800
FA: Violin pref shares: at AC: GCA (A) Balancing 626 369
Preference dividend received and interest income recognised for the
year at the effective rate of 13.081314% (given)
5 January 20X6
Bank (A) 2 032 800
Dividend receivable (A) 2 032 800
Dividend income received
31 December 20X6
FA: Violin pref shares: at AC: GCA (A) Balancing 708 307
year at the effective rate of 13.081314%
5 January 20X7
Bank (A) 2 032 800
31 December 20X7
FA: Violin pref shares at AC (A) Balancing 800 963
5 January 20X8
Bank (A) 2 032 800
31 December 20X8
FA: Violin pref shares at AC (A) Balancing 905 739
5 January 20X9
Bank (A) 2 032 800
Journals continue on next page

b) continued…
Debit Credit
31 December 20X9
FA: Violin pref shares at AC (A) Balancing 1 024 222
Interest income (P/L: I) W1: 3 057 017 3 057 022
year, at the effective rate of 13.081314%
Bank (A) 20 328 000 x 1.2 24 393 600

FA: Violin pref shares at AC (A) 24 393 600
Receipt of the redemption of the preference share capital plus a 20%
premium

b) continued…
WORKINGS
W1: Effective interest rate table – preference shares at amortised cost

Financial Opening Interest income Receipts Closing
year-end: balance at EIR of 13.081314% balance
(given)
(see also W2)
20X5 20 328 000 2 659 169 (2 032 800) 20 954 369
20X6 20 954 370 2 741 107 (2 032 800) 21 662 677
20X7 21 662 677 2 833 763 (2 032 800) 22 463 640
20X8 22 463 640 2 938 539 (2 032 800) 23 369 378
20X9 23 369 379 3 057 022 (2 032 800) 24 393 600
(24 393 600)
14 229 600 (34 557 600)
W2: Effective interest rate (for your interest)

PV = 20 328 000
N=5
PMTS = 2 032 800
FV = 20 328 000 x (20 328 000 x 20%) = 24 393 600
COMP I = 13,081314%

c) Fair value through profit and loss
i) Journals: financial asset at FV through P/L (FVPL)
Debit Credit
1 January 20X5
FA: Violin pref shares: at FVPL (A) Given 20 328 000
Bank (A) 20 328 000
Purchase of Violin’s preference shares (assumed issue price = fair value)
31 December 20X5
Dividend income (P/L: I) 2 032 800
Preference dividend received from Violin
FA: Violin pref shares: at FVPL (A) FV: (C23.20 x 924 000 1 108 800
Fair value gain on financial asset (P/L: I) shares) – Prior CA: 1 108 800
20 328 000
Fair value adjustment to financial assets classified at FVPL
5 January 20X6
Bank (A) 2 032 800
31 December 20X6
FA: Violin pref shares: at FVPL (A) (C27.80 – C23.20) x 924 000 4 250 400
Fair value gain on financial asset (P/L: I) shares; OR 4 250 400
FV: (27.80 x 924 000 shares)
– Prior CA: (20 328 000 +
1 108 800)
5 January 20X7
Bank (A) 2 032 800
31 December 20X7
Fair value loss on financial asset (P/L: E) (C25.50 – C27.80 ) x 2 125 200
FA: Violin pref shares: at FVPL (A) 924 000 2 125 200
OR
FV: (C25.50 x 924 000
shares) – Prior CA:
(20 328 000 + 1 108 800 +
4 250 400)
5 January 20X8
Bank (A) 2 032 800

c) continued…
i) continued…
Debit Credit
31 December 20X8
FA: Violin pref shares: at FVPL (A) (C28.90 – C25.50) x 924 000 3 141 600
Fair value gain on financial asset (P/L: I) OR 3 141 600
FV: (C28.90 x 924 000
(20 328 000 + 1 108 800 +
4 250 400 – 2 125 200)
5 January 20X9
Bank (A) 2 032 800
31 December 20X9
Fair value loss on financial asset (P/L: E) (C26.40 – C28.90) x 924 000 2 310 000
FA: Violin pref shares: at FVPL (A) OR 2 310 000
FV: (C26.40 x 924 000
(20 328 000 + 1 108 800 +
4 250 400 – 2 125 200 +
3 141 600)
Bank (A) C26.40 x 924 000 OR 24 393 600

(20 328 000 + 1 108 800 +
4 250 400 – 2 125 200 +
3 141 600 – 2 310 000)
FA: Violin pref shares: at FVPL (A) 24 393 600
Repayment of capital portion of shares

c) continued …
ii) Disclosure: financial asset is classified at fair value through profit or loss
MELBOURNE LIMITED
STATEMENT OF COMPREHENSIVE INCOME (EXTRACTS)
FOR THE YEAR ENDED 31 DECEMBER 20X8
20X8 20X7
C C
Other income Given 1 025 000 1 025 000
Dividend income See (c) (i) jnls 2 032 800 2 032 800
Fair value gain/(loss) on financial asset See (c) (i) jnls 3 141 600 (2 125 200)
Profit/ (loss) for the period 28 570 080 (48 269 760)
Other comprehensive income xxx xxx
Total comprehensive income xxx xxx
Please note: The column for 20X7 is required because we were asked to prepare the statement of
comprehensive income (SOCI) in terms of IFRS and IFRS (IAS 1) requires at least one
comparative year to be presented in the SOCI.

d) Journals: financial asset at fair value through other comprehensive income
Debit Credit
1 January 20X5
FA: Violin pref shares at FVOCI (A) Fair value 20 328 000 + 20 328 000
Bank (A) Transaction costs: 0 20 328 000
Purchase of Violin’s preference shares (assumed issue price = fair
value)
31 December 20X5
FA: Violin pref shares at FVOCI (A) Balancing 626 369
year at the effective rate of 13.08134% (given)
FA: Violin pref shares at FVOCI (A) 21 436 800 (W2) – 20 954 369 482 431
(W1)
FV gains (OCI) 482 431
Measurement of preference shares at FV, with the adjustment recognised in OCI
5 January 20X6
Dividend received
31 December 20X6
FA: Violin pref shares at FVOCI (A) 25 687 200 (W2) – (21 662 676 3 542 093
(W1) + 482 431)
FV gains (OCI) 3 542 093
5 January 20X7
Dividend received
31 December 20X7
FV loss (OCI) 23 562 000 (W2) – (22 463 639 2 926 163
(W1) + 482 431 + 3 542 093)
FA: Violin pref shares at FVOCI (A) 2 926 163
5 January 20X8
Dividend received

d) continued …
Debit Credit
31 December 20X8
FA: Violin pref shares at FVOCI (A) 26 703 600 (W2) – (23 369 378 2 235 861
(W1) + 482 431 + 3 542 093 –
2 926 163)
FV gain (OCI) 2 235 861
5 January 20X9
Dividend received
31 December 20X9
Bank (A) (1) Given 2 032 800
FA: Violin pref shares at FVOCI (A) Balancing 1 024 222
year, at the effective rate of 13.08134%
FV loss (OCI) 24 393 600 (W2) – (24 393 600 3 334 222
(W1) + 482 431 + 3 542 093 –
2 926 163 + 2 235 861)
Bank (1) 20 328 000 x 1.2 24 393 600

Receipt of the redemption of the preference share capital plus a 20%
premium
(1): Please note that these two payments were made together to Melbourne actually only had
one single receipt of the total thereof. These receipts have been shown separately to make the
journals more understandable for you.

d) continued…
WORKINGS
W1: Effective interest rate table – preference shares at amortised cost

Financial Opening Interest income Receipts Closing
year-end: balance at EIR of 13.08134% balance
(given)
(see also W3)
20X5 20 328 000 2 659 169 (2 032 800) 20 954 369
20X6 20 954 369 2 741 107 (2 032 800) 21 662 676
20X7 21 662 676 2 833 763 (2 032 800) 22 463 639
20X8 22 463 639 2 938 539 (2 032 800) 23 369 378
20X9 23 369 378 3 057 022 (2 032 800) 24 393 600
(24 393 600)
14 229 600 (34 557 600)
W2: Fair value calculations

Financial year-end Fair value
20X5 23.20 x 924 000 21 436 000
20X6 27.80 x 924 000 25 687 200
20X7 25.50 x 924 000 23 562 000
20X8 28.90 x 924 000 26 703 600
20X9 26.40 x 924 000 24 393 600
W3: Effective interest rate (for your interest)

PV = 20 328 000
N=5
PMTS = 2 032 800
FV = 20 328 000 x 120% = 24 393 600
COMP I = 13,081314%

Solution 21.9
Journals – Investment in bonds issued by Black Jack Limited
Debit Credit
02 January 20X7
FA: Bonds: FVPL (A) 15 000 x C46 (FV per bond) 690 000
Bank (A) 15 000 x C40 (cost per bond) 600 000
Gain on acquisition of bonds (P/L: I) Balancing 90 000
Recognition of bonds: initially measured at fair value. The difference
between the fair value and the transaction price is a day-1 gain.
Note:
The bonds are traded on the open market and thus the FV has been
determined based on level 1 inputs (i.e. the FV was reliably
measured), and thus the day-1 gain is recognised immediately in P/L.
31 December 20X7
FA: Bonds: FVPL (A) 15 000 x (C50.50 – C46) 67 500
FV gain on financial asset (P/L: I) 67 500
Subsequent measurement of the bonds to their year-end FV.
The FV gain is recognised in P/L because the investment is classified
at FVPL
Bank (A) C40 x 15 000 x 10% 60 000

Finance income (P/L: I) 60 000
Interest income received from bonds
Journals – Investment in ordinary shares issued by Poker (Pty) Ltd
Debit Credit
02 January 20X7
FA: Unlisted shares: FVPL (A) 6 000 x C33 (FV per share) 198 000
FA: Unlisted shares: Deferred loss (A) Balancing; or 6 000 x C4.50 27 000
Brokerage fees expense (P/L: E) 6 000 x C1 (transaction costs) 6 000
Bank 6 000 x C37.50 (cost per share) 231 000
+ 6 000 x C1 (transaction costs)
Recognition of unlisted shares at fair value. The difference between
the fair value and the transaction price is a day-1 loss. Transaction
costs are expensed since the investment is classified at FVPL.
Note:
The FV of Poker’s unlisted shares was not reliably measurable (i.e.
the FV measurement performed by the consultancy involved the use
of level 3 inputs in a discounted cash flow analysis), and thus the day-
1 loss is deferred.
31 December 20X7
FA: Unlisted shares: FVPL (A) 6 000 x (C40 – C37.50) 15 000
FV gain on financial asset (P/L: I) 15 000
The FV gain is recognised in P/L because the investment is classified
at FVPL
Continues on the next page …

Journals – Investment in shares issued by Roulette Limited
Debit Credit
02 January 20X7
FA: listed shares: FVOCI (A) 20 000 x C77.50 + C1 750 1 551 750
Gain on acquisition of shares (P/L: I) Balancing; or 20 000 x C2.50 50 000
Bank 20 000 x C75 (cost per share) 1 501 750
+ C1 750 (transaction costs)
Recognition of listed shares at fair value. Transaction costs are
capitalised to the investment because it is classified at FVOCI. The
difference between the transaction price and the fair value is a day-1
gain. This day-1 gain is recognised in P/L because the share is a listed
share & the FV was determined based on level 1inputs.
31 December 20X7
FA: listed shares: FVOCI (A) Latest FV: (20 000 x C84) – 128 250
FV gain on financial asset (OCI) Prior CA: 1 551 750 128 250
The FV gain is recognised in OCI because the investment is classified
at FVOCI
Bank 20 000 x C1 (dividend) 20 000

Dividend income (P/L) 20 000
Receipt of the dividend income.
Note that the dividend income is recognised in P/L even though the
FA is classified at FVOCI

Solution 21.10
Approach to answering this question
As always, if you were faced with a question such as this in a test situation, you need to be guided
by the mark allocation to determine the extent of the detail to include in your answer. The
following ‘comprehensive discussion’ provides a comprehensive answer that could have been
provided as the ‘general theory’ under Part A, B or C. This comprehensive discussion is for your
interest. Shorter versions of this discussion are provided as the solutions to Part A, B and C – these
shorter versions are shown after this comprehensive discussion.
Comprehensive discussion (for your interest)
General theory (NOT part of the solution – added for your interest only):
The impact of the classification of the financial asset and whether an expected credit loss
allowance is required
All three loans (i.e. the loans in Part A, B and C) would be classified at ‘amortised cost’ (unless
this would lead to an accounting mismatch, in which case it would be classified at ‘FV through
profit or loss’ instead). This is because the loans provided to each of the three clients:
• render returns that represent solely returns of principal plus interest on principal; and
• appear to be held under a business model to collect the contractual cash flows.
When recognizing financial assets that are classified at ‘amortised cost’, we must also recognize
a loss allowance based on expected credit losses (ECL).
Loss allowances and the two approaches
An expected credit loss allowance may be accounted for in terms of the general approach or the
simplified approach. Since, however, the simplified approach is only available when dealing
with trade receivables, lease receivables and contract assets, the expected credit loss allowance
relating to the loan asset must be accounted for in terms of the general approach.
Under the general approach
• If there is objective evidence that a financial asset is credit-impaired on date of initial

recognition, then its fair value would already be depressed and thus would already reflect
the expected credit losses. Thus, we do not recognize a loss allowance account on the date
of initial recognition (otherwise it would be double-counting the effect of the impairment).
Instead of recognizing a loss allowance on initial recognition, we will recognize interest

income using a credit-adjusted effective interest rate, which is calculated based on the
expected actual cash flows, after taking into account the lifetime expected credit losses.
Although a loss allowance is not recognized on the initial recognition date, a loss allowance
would be recognized subsequently if the estimated lifetime expected credit losses
subsequently change from the lifetime expected credit losses that were estimated on the date
of initial recognition of the asset.

General theory continued …
In other words, the subsequent measurement of such an asset will require the recognition
of a loss allowance to reflect any cumulative changes to the initial lifetime expected credit
losses that would have been reflected in the initial fair value. See IFRS 9.5.5.13
Interest income will be measured by applying a credit-adjusted effective interest rate

determined at initial recognition to the amortised cost (i.e. amortised cost = gross carrying
amount – loss allowance, if any). See IFRS 9.B5.5.45
The credit-adjusted effective interest rate is used only for financial assets that are credit-
impaired on initial recognition. It is the rate that reflects the expected future cash flows after
taking into account the ‘initial expected credit losses’. In other words, it is the rate that
exactly discounts the future expected cash flows (i.e. the expected actual cash flows after
excluding all expected credit losses, rather than the expected contractual cash flows) to the
amortised cost. See IFRS 9.B5.4.7 and IFRS 9 App A
The interest income must always be calculated in this way (even if the credit risk of the
asset improves such that it is no longer considered to be credit-impaired). See IFRS 9.5.4.1 (a) and
IFRS 9.5.4.2
Similarly, the loss allowance must always reflect the latest estimate of the ‘lifetime expected
credit losses’, even if the credit risk were to improve to the point that the asset was no longer
considered to be credit-impaired. See IFRS 9.5.5.13 and IFRS 9.5.5.14
A credit loss is the present value of the expected cash shortfall (contractual cash flows – actual
cash flows expected). When dealing with a financial asset that is ‘credit-impaired on initial
recognition’, we calculate the present value by discounting the expected cash shortfall at the
‘credit-adjusted effective interest rate’. See IFRS 9 App A
The expected credit loss is the ‘weighted average of credit losses (i.e. the PV of the expected
shortfall) with the respective risks of a default occurring as the weights’. See IFRS 9 App A
The lifetime expected credit loss reflects the expected credit losses resulting ‘from all possible
default events over the expected life of a financial instrument’. See IFRS 9 App A
• If there is no such objective evidence of the loan asset being credit-impaired on the date that
it is initially recognised, then a loss allowance must be recognized on this date, and this must
initially be measured based on the ‘12-month expected credit loss’.
The 12-month expected credit loss is ‘the portion of the lifetime expected credit losses’ that
reflect the ‘expected credit losses’ that would ‘result from the default events…that are possible
within the 12 months after reporting date’. See IFRS 9 App A
Interest income will be measured by applying the effective interest rate, determined on initial
recognition, to the gross carrying amount (this approach may change if the asset becomes
credit-impaired at a later date). See IFRS 9.5.4.1
The effective interest rate is the rate that exactly discounts the future contractual cash flows
(ignoring the possibility of expected credit losses) to the gross carrying amount. See IFRS 9 App A

General theory continued …
The subsequent measurement of the loss allowance account requires a reassessment of the
credit risks at subsequent reporting dates: the loss allowance will be remeasured either to the
latest estimate of the potential ‘12-month expected credit loss’ or to the ‘lifetime expected
credit loss’.
− If the asset’s credit risk has not increased significantly since initial recognition, then the
loss allowance would simply need to be remeasured to reflect the latest estimate of the
‘12-month expected credit losses’. See IFRS 9.5.5.5
Interest income would continue to be measured by multiplying the original effective

interest rate by the gross carrying amount (i.e. not net of the loss allowance). See IFRS 9.5.4.1
If the asset’s credit risk is low at reporting date, then the entity is entitled to assume that
the credit risk has not increased significantly. See IFRS 9.5.5.10
− If the asset’s credit risk has increased significantly since initial recognition, then the loss
allowance must be remeasured to reflect ‘lifetime expected credit losses’. See IFRS 9.5.5.3
The measurement of interest income would be affected by whether or not, in addition to

the significant increase in credit risk, the asset has also become credit-impaired.
- If the asset has not also become ‘credit-impaired’, then the interest income would
continue to be measured by multiplying the original effective interest rate by the gross
carrying amount (i.e. not net of the loss allowance). See IFRS 9.5.4.1
- If the asset has also become ‘credit-impaired’, then the interest income would now be
measured by multiplying the original effective interest rate by the amortised cost (the
gross carrying amount net of the loss allowance). See IFRS 9.5.4.1 (b)
− If the asset’s credit risk increased significantly in a prior period, with the result that the
loss allowance was remeasured to reflect ‘lifetime expected credit losses’, but, at the
current reporting date, the credit risk has now dropped such that it no longer reflects a
significant increase in credit risk since initial recognition, then the loss allowance at this
current reporting date must be remeasured to, once again, reflect ‘12-month expected
credit losses’. See IFRS 9.5.5.7
Similarly, if the asset had previously been considered to have become credit-impaired but
is no longer considered to be credit-impaired, then the interest income would then revert
to being measured by multiplying the original effective interest rate by the gross carrying
amount (i.e. not amortised cost). See IFRS 9.5.4.2

Part A
a) Discussion – loan to Stadium Limited – measurement of the ECL allowance
Application of the general theory to the loan asset provided to Stadium Limited:
• Stadium had never defaulted on its previous loans, suggesting there is no evidence the loan
to Stadium was credit-impaired on the date the loan originated and possibly even suggesting
that the credit risk was low.
• Since the loan asset was not credit-impaired on initial recognition:
− a separate loss allowance would need to be recognized on initial recognition of the loan
asset (i.e. on 2 January 20X1); and
− this loss allowance would be initially measured at the 12-month expected credit loss of
C216 000 (C6 000 000 x 3.6%) (this amount is a present value, representing the expected
credit losses that would occur based on default events that the entity expects may occur
in the 12-month period after the reporting date).
• At each subsequent reporting date, the loan asset’s credit risk would then need to be
reassessed and the loss allowance remeasured.
• If, when re-assessing the asset’s credit risk at a subsequent reporting date, the credit risk:
− had not increased significantly but the estimate of the 12-month expected credit loss
had changed, we must simply remeasure the carrying amount of the loss allowance
account to reflect the latest estimate of the ‘12-month expected credit loss’; or
− had increased significantly, we must remeasure the loss allowance account to reflect
‘lifetime expected credit losses’ (i.e. instead of ‘12-month expected credit losses’).
• No evidence is given of a change in either the credit risk or in the estimate of the 12-month
expected credit loss at 31 December 20X1 and thus no further adjustment to the loss
allowance would be required during the 20X1 financial period.

b) Journals - loan to Stadium Limited
Debit Credit
2 January 20X1
FA: Loan: at AC: GCA (A) Given 6 000 000
Bank 6 000 000
Loan capital (asset) paid to Stadium, classified at amortised cost
FA: Loan: at AC: GCA (A) Given 57 200
Bank 57 200
Transaction costs paid in respect of loan asset (transaction costs capitalised
since the loan asset is classified at amortised cost)
Impairment loss (P/L: E) C6 000 000 x 3.6% 216 000
FA: Loan: at AC: Loss allowance (-A) 216 000
Initial recognition of loss allowance relating to loan asset (Stadium),
measured at 12-month expected credit losses (because not credit-impaired
on origination)
31 December 20X1
Bank C6 000 000 x 12% 720 000
Interest income (P/L: I) C6 057 200 x 11,73726% (EIR); 710 949
Or W1
FA: Loan: at AC: GCA (A) Balancing 9 051
Recognition of receipt of interest and the interest income on the loan asset
to Stadium Limited (EIR method)
31 December 20X2
Bank C6 000 000 x 12% 720 000
Interest income (P/L: I) (C6 057 200 – 9 051) 709 887
x 11,73726% (EIR); Or W1
31 December 20X3
Bank C6 000 000 x 12% 720 000
Interest income (P/L: I) (C6 057 200 – 9 051 – 10 113) 708 700
x 11,73726% (EIR); Or W1
Key: AC = Amortised cost GCA = Gross carrying amount
Comment:
No evidence of a change in the estimated 12-month expected credit losses was provided and thus no
journals adjusting the measurement of the loss allowance at 31 December 20X1 have been processed.

b) continued…
WORKINGS (Stadium Limited):
W1: Effective interest rate table (Stadium Limited loan)
Opening Interest income at Interest received at interest Closing

balance effective interest rate of balance
rate of 11,73726% 12%, plus receipt of capital
(see W1.1) in 20X5
20X1 6 057 200 710 949 (720 000) 6 048 149
20X2 6 048 149 709 887 (720 000) 6 038 036
20X3 6 038 036 708 700 (720 000) 6 026 735
20X4 6 026 735 707 373 (720 000) 6 014 109
(1)
20X5 6 014 109 705 891 (6 720 000) 0
3 542 800 (9 600 000)
(1): Interest: 720 000 + Capital (ignoring defaults): 6 000 000 = 6 720 000
W1.1: Effective interest rate (Stadium Limited loan)
The EIR of 11,73726% was calculated as follows:

PV: GCA: -6 000 000 (FV) – 57 200 (Transaction costs) = -6 057 200
PMTs: 6 000 000 x 12% = 720 000
N: 5
FV: 6 000 000
COMP: Answer = 11,73726%
For your interest…

If the estimate of the loss remained unchanged throughout (i.e. at the end of each year the entity expected
a default to occur within the following 12 month period that would result in a loss of C216 000) and that
this loss eventually did occur when Stadium defaulted when repaying the capital on 31 December 20X5,
the journals in 20X4 and 20X5 would be as follows:
Debit Credit
31 December 20X4
Bank C6 000 000 x 12% 720 000
Interest income (P/L: I) W1 707 373
Recognition of receipt of interest and the interest income on the loan
asset to Stadium Limited (EIR method)
31 December 20X5
Bank C6 000 000 x 12% 720 000
asset to Stadium Limited (EIR method)
Bank C6 000 000 – Default 216 000 5 784 000
FA: Loan: at AC: GCA (A) Capital owed by debtor 6 000 000
FA: Loan: at AC: Loss allowance (-A) 12-m expected credit loss 216 000
Receipt of capital repayment reflecting a shortfall of C216 000

Part B
a) Discussion – loan to Boots Limited – measurement of the ECL allowance
Application of the general theory to the loan asset provided to Boots Limited
• There is no evidence suggesting the loan to Boots Limited was credit-impaired on the date the
loan originated (2 January 20X1).
• Since the loan asset was not credit-impaired on initial recognition:
− a separate loss allowance must be recognized on initial recognition of the loan asset (i.e.
on 2 January 20X1); and
− this loss allowance would need to be initially measured at the 12-month expected credit
loss of C50 400 (C1 440 000 x 3,5%) (this amount is a present value, representing the
portion of the lifetime expected credit losses that would arise in the 12-month period
after the reporting date due to certain default events that the entity expects may possibly
occur during this 12-month period).
• The loan asset’s credit risk would then need to be reassessed and the loss allowance
remeasured at each subsequent reporting date.
• If the credit risk:
− had not increased significantly but the estimate of the 12-month expected credit loss
had changed, we would need to remeasure the carrying amount of the loss allowance
account to reflect the latest estimate of the ‘12-month expected credit loss’; or
− had increased significantly, the loss allowance account would have to be remeasured to
‘lifetime expected credit losses’ (i.e. instead of ’12-month expected credit losses’).
• No evidence is given of a change in either the credit risk or in the estimate of the 12-month
expected credit loss at 31 December 20X1 and thus no further adjustment to the loss
allowance is required during the 20X1 financial period.

a) continued…
For your interest only
If the question had asked for a full discussion relating to 20X3 (for your interest only)
The question only required a discussion of the measurement of the loss allowance for the year
ended 31 December 20X1. However, if the question had also required a discussion relating to the
year ended 31 December 20X3, when there was a significant increase in credit risk, the following
discussion would be appropriate:
In 20X3, the client’s notification and request for an extension, was taken as an indication of a
‘significant increase in credit risk’. However, we are not told that the asset was also considered to
be ‘credit-impaired’. Thus, in 20X3, the loan is considered ‘stage 2’, (i.e. the asset is ‘under-
performing’). In this case:
• the carrying amount of the loss allowance account at 31 December 20X3 would need to be
remeasured to reflect ‘lifetime expected credit losses’; and
• the interest income in the following year (20X4) would continue to be measured by applying
the original effective interest rate to the gross carrying amount.
However, since the terms of the loan were modified, effective from 1 January 20X4, the GCA
would be revised to reflect the PV of the revised future cash flows, discounted using the same
original effective interest rate and the difference between the previous GCA balance and this
revised GCA balance will be recognized as a modification loss (or gain) in profit or loss.
If Choule Limited also concluded that the asset had become credit-impaired
If the information surrounding the client in 20X3 had suggested that there had not only been a
‘significant increase in credit risk’, but that the financial asset was now also ‘credit-impaired’,
then, during the year ended 31 December 20X3, the loan would be considered ‘stage 3’ (i.e. the
asset is ‘not performing’). In this case:
• the carrying amount of the loss allowance account at 31 December 20X3 would need to be
remeasured to reflect ‘lifetime expected credit losses’; and
• the interest income in the following year (20X4) would be measured by applying the original
effective interest rate to the amortised cost (gross carrying amount – loss allowance) (note the
difference from the situation, described above, in which there is a significant increase in credit
risk but the asset is not considered credit-impaired, in which case the interest income is
measured by applying the original effective interest rate to the gross carrying amount … not
the amortised cost).

Part B continued…
b) Journals – loan to Boots Limited

Debit Credit
2 January 20X1

Bank 1 440 000
Loan capital (asset) paid to Boots, classified at amortised cost

Bank 10 400
Transaction costs paid in respect of loan asset (transaction costs
capitalised since the loan asset is classified at amortised cost)
Impairment loss (P/L: E) C1 440 000 x 3,5% 50 400

FA: Loan: at AC: Loss allowance (-A) 50 400
Initial recognition of loss allowance relating to loan asset (Boots),
measured at 12-month expected credit losses (because not credit-
impaired on origination)
31 December 20X1
Bank C1 440 000 x 15% 216 000

Interest income (P/L: I) FA: Loan: GCA bal: 1 450 400 214 451
x EIR: 14,78564%; Or W1
Recognition of receipt of interest and the interest income on the
loan asset to Boots Limited (EIR method)
31 December 20X2
Bank C1 440 000 x 15% 216 000

Interest income (P/L: I) FA: Loan: GCA bal: (1 450 400 – 214 222
1 549) x EIR: 14,78564%; Or W1
31 December 20X3
Bank C1 440 000 x 15% 216 000

Interest income (P/L: I) FA: Loan: GCA bal: (1 450 400 – 213 959
1 549 – 1 778) x EIR: 14,78564%;
Or W1
FA: Loan: AC: GCA (A) Balancing 2 041
Modification loss (P/L: E) W2 161 343

FA: Loan: AC: GCA (A) 161 343
Loss on financial asset due to re-negotiated terms
Impairment loss (P/L: E) W3 165 600

FA: Loan: AC: Loss allowance (-A) 165 600
Remeasurement of loss allowance to reflect lifetime expected credit
losses (due to significant increase in credit risk)
Key: AC = Amortised cost GCA = Gross carrying amount

Part B continued…
b) continued…
Comment:
Boots Limited involves:
• no measurement adjustments to the loss allowance at the 20X1 or 20X2 reporting dates:
this is because there was no evidence given, at the end of either 20X1 or 20X2, of either a
significant increase in credit risk (which would have meant remeasuring the allowance to
reflect ‘lifetime expected credit losses’) or a change in the estimated 12-month expected
credit losses;
• a measurement adjustment to the loss allowance at the 20X3 reporting date was necessary
because this account now needed to reflect ‘lifetime expected credit losses’ instead of ‘12-
months expected credit losses’: this is because there was a significant increase in credit risk
(note: the asset does not appear to become credit-impaired and is thus only taken to stage 2
– not stage 3 – and thus the effective interest income in 20X4 and beyond would still be
measured by applying the EIR to the GCA);
• a modification of terms: this modification was assumed not to result in a derecognition of

the original financial asset.

Part B continued…
b) continued …
WORKINGS (Boots Limited)
W1: Effective interest rate table (Boot Limited loan) – on initial recognition
Opening Interest income at Receipts (interest Closing

balance EIR of 14,78564% (W1.1) received at 15%) balance
20X1 1 450 400 214 451 (216 000) 1 448 851
20X2 1 448 851 214 222 (216 000) 1 447 073
20X3 1 447 073 213 959 (216 000) 1 445 032
20X4 1 445 032 213 657 (216 000) 1 442 689
20X5 1 442 689 213 311 (1 656 000) (1) 0
1 069 600 (2 520 000)
(1): Interest: 216 000 + Capital (ignoring defaults): 1 440 000 = 1 656 000
W1.1: Effective interest rate (Boot Limited loan) – on initial recognition

The EIR of 14,78564% was calculated as follows:
PV: GCA = – 1 440 000 (FV) – 10 400 (Transaction costs) = -1 450 400
PMTs: 1 440 000 x 15% = 216 000
N: 5
FV: 1 440 000
COMP: Answer = 14,7856423%
W2: Loss due to modification of terms
PV of loan asset at 31/12/20X3 based on the renegotiated terms (but discounted using the original EIR):
EIR = W1.1 = 14,7856423%
N = 4 (new terms effective from 1 January 20X4 and extension to 31 December 20X7)
PMT = C1 440 000 x 11% = C158 400
FV = C1 440 000
Comp PV = C1 283 689
Impairment loss =
= PV before modification: C1 445 032 (W1) – PV after modification: C1 283 689 (above)
= C161 343
W3: Remeasurement of loss allowance to reflect lifetime expected credit losses
C1 440 000 x 15% (life-time ECLs) – C1 440 000 x 3,5% (previous balance at 12-month ECLs) =
C165 600
W4: Effective interest rate table (Boots Limited loan) – after modification (see W2) (For interest)
Opening Interest income at Receipts (interest at Closing

balance EIR of 14,78564% (W1.1) 15%, then 11%) balance
20X1 1 450 400 214 451 (216 000) 1 448 851
20X2 1 448 851 214 222 (216 000) 1 447 073
20X3 1 447 073 213 959 (216 000) 1 445 032
Modification loss (W2) (161 343)
Revised closing balance (20X3) (W2) 1 283 689
20X4 1 283 689 189 801 (158 400) 1 315 090
20X5 1 315 090 194 445 (158 400) 1 351 135
20X6 1 351 135 199 774 (158 400) 1 392 509
20X7 1 392 509 205 891 (1 598 400) 0
1 432 543 (2 721 600)
Notice: the EIR remains unchanged.

Part C
a) Discussion – loan to Coach Limited – measurement of the ECL allowance
Application of the general theory to the loan asset provided to Coach Limited
At inception (origination), Coach Limited was regarded as ‘high risk’ due to their poor credit
rating and was assessed as being credit-impaired at origination.
• No loss allowance will be recognized on initial recognition because the ‘lifetime expected
cash shortfall’ of C900 000 (being a single default expected to occur on 31 December 20X5)
would have effectively been factored into both its fair value of C2 000 000 (given) and the
credit-adjusted effective interest rate of 15,058724% (W1), both determined at initial
recognition (2 January 20X1).
On initial recognition, the ‘lifetime expected credit loss’ (being the present value of the
‘lifetime expected cash shortfall’ of C900 000) is C446 318 (W2). However, a separate loss
allowance account of C446 318 is not recognized on this date because this loss is
theoretically already reflected in the asset’s fair value on this date. In other words, if the
asset had not been credit-impaired on initial recognition, theoretically the fair value would
have been C2 446 318 (C2 000 000 + C446 318).
• However, if the amount of the ‘lifetime expected credit loss’ (being the PV of the ‘lifetime
expected cash shortfall’) changes over time (i.e. becomes greater or less than C446 318), a
separate loss allowance account will need to be recognized to reflect the cumulative change
in the lifetime expected credit loss since the date of the initial recognition. The contra entry,
if and when recognizing a loss allowance account, will be recognized as an impairment loss
or gain in profit or loss.
• The interest income on a ‘purchased or originated credit-impaired financial asset’ is

measured by applying the credit-adjusted effective interest rate (15,058724% - see W1) to
the amortised cost (i.e. amortised cost = gross carrying amount – loss allowance).
Since the asset was credit-impaired on initial recognition and thus since there is no separate
loss allowance recognized on the date of the initial recognition of the asset, this amortised
cost will initially equal the gross carrying amount (Amortised cost on initial recognition =
GCA: C2 018 400 – Loss allowance: 0 = C2 018 400).
The amortised cost will only differ from the gross carrying amount if and when there is a
subsequent change in the lifetime expected credit loss and thus if and when a loss allowance
account is recognized. Since no evidence was provided of a subsequent change to this
estimated lifetime expected credit loss during 20X1, no separate loss allowance account will
be recognized during 20X1.

a) continued…
WORKINGS:
W1: Credit-adjusted effective interest rate on 2 January 20X1
PV: Amortised cost = GCA – Loss allowance = -[GCA: (FV: 2 000 000 + Transaction costs: 18 400) –
LA: 0] = -2 018 400
PMTs: 2 000 000 x 22% = 440 000
N: 5
FV: 2 000 000 – expected cash shortfall: C900 000 = 1 100 000
COMP i: Answer = 15,058724%
W2: Lifetime expected credit loss on 2 January 20X1
FV = 900 000 (expected cash shortfall after 5 years – given)

N = 5 (the above default is expected on 31/12/X5)
i = 15,0587243% (see W1)
Comp PV: Answer = 446 318

Part C continued…
b) Journals – loan to Coach Limited

Debit Credit
2 January 20X1
Bank 2 000 000
Loan capital (asset) paid to Coach, classified at amortised cost
Bank 18 400
Transaction costs paid in respect of loan asset (transaction costs
capitalised since the loan asset is classified at amortised cost)
31 December 20X1
Bank C2 000 000 x 22% 440 000
Interest income (P/L: I) AC bal*: 2 018 400 x 15,058724%; or W1 303 945
asset to Coach (EIR method). Note: the interest income is based on a
credit-adjusted EIR and this rate is applied to amortised cost
*: Amortised cost = GCA 2 018 400 – LA nil = 2 018 400
31 December 20X2
Bank C2 000 000 x 22% 440 000
asset to Coach (EIR method). Note: the interest income is based on a
credit-adjusted EIR and this rate is applied to amortised cost
*: Amortised cost = GCA (2 018 400 – 136 055) – LA nil = 1 882 345
31 December 20X3
Bank C2 000 000 x 22% 440 000
to Coach (EIR method). Note: the interest income is based on a credit-
adjusted EIR and this rate is applied to amortised cost
*: Amortised cost = GCA (2 018 400 – 136 055 – 156 543) – LA nil = 1 725 802
31 December 20X4 (for your interest only)

Bank C2 000 000 x 22% 440 000
*: AC = GCA (2 018 400 – 136 055 – 156 543 – 180 116) – LA nil = 1 545 686
31 December 20X5 (for your interest only)

Bank C2 000 000 x 22% 440 000
*: Amortised cost = GCA (2 018 400 – 136 055 – 156 543 – 180 116 – 207 239)
– LA nil = 1 338 447

b) continued…
Debit Credit
31 December 20X5 (for your interest only) continued…
Bank C2 000 000 – 900 000 shortfall 1 100 000
FA: Loan: at AC: GCA (A) Balance in this acc: 2 018 400 – 136 055 – 1 100 000
156 543 – 180 116 – 207 239 – 238 447
Recognition of receipt of loan capital repaid, net of the shortfall (i.e. in
this journal, we are assuming that the borrower repaid C900 000 less
than he should have – in other words, that the entity’s original estimate
of the future expected cash shortfall was 100% correct)
Key: AC = Amortised cost GCA = Gross carrying amount LA = Loss allowance
Comment:
In this question, the financial asset is credit-impaired on initial recognition. This means the following:
• The EIR used (i.e. to calculate interest income and to calculate the PV of the expected future cash
shortfalls, i.e. lifetime expected credit losses) must be the credit-adjusted EIR determined at date of
initial recognition.
• No loss allowance will be recognized on initial recognition.
• A loss allowance will only be recognized, after initial recognition, if the expected credit losses that
were determined on initial recognition, subsequently change. In that case, the measurement of the
loss allowance recognized would reflect the cumulative change in the expected credit losses since
initial recognition (i.e. the loss allowance at any particular reporting date would not reflect the total
expected credit loss at that date). We are not given evidence that the entity changed its estimate of
the abovementioned expected cash shortfall during the life of this asset and thus no loss allowance
has been recognized during its life.
• Interest income in each period will be measured by applying the credit-adjusted EIR to the amortised
cost balance (i.e. the net financial asset = amortised cost = GCA balance - loss allowance balance, if
any) instead of applying it to the GCA balance (i.e. the gross financial asset).
P.S.
• In this question, we are told that the lifetime expected cash shortfall is C900 000, representing an
expected default of this amount at 31 December 20X5.
• A ‘lifetime expected cash shortfall’ is not the same as an ‘expected lifetime expected credit loss’.
− A credit loss (446 318) is the present value of the expected cash shortfall (900 000). See IFRS 9 App A
− The expected credit loss is the ‘weighted average of credit losses with the respective risks of a
default occurring as the weights’. See IFRS 9 App A In this case, there was only one possible loss, with a
weighting of 1, so the credit loss of 446 318 equals the expected credit loss.
− The lifetime expected credit loss reflects the expected credit losses resulting ‘from all possible
default events over the expected life of a financial instrument’. See IFRS 9 App A Since there was only 1
possible default expected over the asset’s life, the expected credit loss (446 318) also equals the lifetime
expected credit loss.
• The present value of a default of C900 000 after 5 years, discounted at the credit-adjusted EIR of
15,0587243% (see W1.1), is C446 318 (Using a financial calculator: FV = 900 000; N = 5; i =
15,0587243%; Comp PV)
• However, although the loss allowance account normally reflects the expected credit loss, in the case
of a ‘purchased/originated credit-impaired financial asset’ we do not recognize a loss allowance of
C446 318 on initial recognition. This is because, theoretically, the fair value of C2 000 000 would
have already reflected the impairment. In other words, if the asset had not been considered to be
credit-impaired on initial recognition, the entity believes its fair value on initial recognition would
have been C2 446 318 (the given FV: 2 000 000 + expected credit loss: 446 318).

b) continued …
WORKINGS (Coach Limited)
W1: Effective interest rate table (Coach Limited loan) – on initial recognition
Opening Interest income at Receipts (interest Closing

balance EIR of 15.058724% received at 22%) balance
(W1.1)
20X1 2 018 400 303 945 (440 000) 1 882 345
20X2 1 882 345 283 457 (440 000) 1 725 802
20X3 1 725 802 259 884 (440 000) 1 545 686
20X4 1 545 686 232 761 (440 000) 1 338 447
(1)
20X5 1 338 447 201 553 (1 540 000) 0
1 281 600 (3 300 000)
(1): Interest: 440 000 + Capital – expected default: (2 000 000 – 900 000) = 1 540 000
Please note that, because Coach Limited was credit-impaired on initial recognition:
• The EIR is applied to its amortised cost (gross carrying amount – loss allowance) – and not to its
gross carrying amount. However, since it is credit-impaired on initial recognition, there is no loss
allowance that is immediately recognised and thus the interest revenue will start by being measured
at the opening balance reflected in the above effective interest rate table of C2 018 400 (GCA:
C2 018 400 – LA: C0).
• It also means we must use a ‘credit-adjusted effective interest rate’ (please note, however, that where
an asset becomes credit-impaired after initial recognition, we would continue to use the original
‘effective interest rate’).
W1.1: Effective interest rate (Coach Limited loan) – on initial recognition
The credit-adjusted EIR of 15,058724% was calculated as follows:

PV: Amortised cost = GCA – Loss allowance
= -[GCA: (FV: 2 000 000 + Transaction costs: 18 400) – LA: 0]
= -2 018 400
PMTs: 2 000 000 x 22% = 440 000
N: 5
FV: 2 000 000 - C900 000 = 1 100 000
COMP: Answer = 15,058724%
Please note that, because Coach Limited was credit-impaired on acquisition (as opposed to simply
becoming credit-impaired after acquisition), the EIR used for Coach Limited is a credit-adjusted EIR,
which means it must exactly discount the future actual expected cash flows (not the contractual cash
flows) to the amortised cost of C2 018 400 (amortised cost = gross carrying amount – loss allowance).

Solution 21.11
Investment in unlisted non-redeemable preference shares
The investment in unlisted preference shares represents a debt instrument that does not meet
the criteria to be classified either as at amortised cost or as at fair value through other
comprehensive income. This is because, although the instrument provides a return of
contractual cash flows, these cash flows only include interest: the principal amount will not be
returned since the investment will be held in perpetuity.
It is therefore appropriate to classify this investment as at fair value through profit or loss.
The investment will be initially measured at its fair value of C520 000 with the transaction costs
of C5 200 being expensed. The investment will then be remeasured to fair value at reporting
date with fair value gains or losses recognised in profit or loss.
When an instrument is subsequently measured at fair value through profit and loss, it is not
necessary to assess the expected credit losses relating to the instrument.
The journal entries will be as follows:

Debit Credit
1 January 20X1
FA: Investment: FVPL (A) 520 000

Transaction costs (P/L: E) 5 200
Bank 525 200
Recognition of financial asset classified at fair value through profit
or loss, initially measured at FV with transaction costs expensed.
31 December 20X1
Bank 52 000
Dividend income (P/L: I) 52 000
Recognition of dividend income received on the preference shares
FA: Investment: FVPL (A) FV 560 000 – Prior CA: 520 000 40 000
Fair value gain on investment (P/L: I) 40 000
Recognition of fair value movements on the preference shares
Investment in redeemable preference shares
The investment in the unlisted redeemable preference shares meets the criteria to be classified
at amortised cost:
• The preference shares offer contractual cash flows made up of the interest (at 15%) and the
return of the principal (i.e. the CCF criterion is met); and
• Mpofana intends to collect these cash flows (i.e. the business model is ‘held to collect’).
It should also be noted that this investment, despite meeting the criteria to be classified at
amortised cost, could be classified at fair value through profit or loss instead if this would avoid
an accounting mismatch. However, as there are no accounting mismatches present, Mpofana
will have to classify the investment at amortised cost.

As the investment is classified at amortised cost, it will initially be measured at its fair value of
C350 000 with the transaction costs of C3 500 capitalised to this account (i.e. initial measurement
is C353 500). The investment would then be measured at amortised cost, which involves
recognising interest income using the effective interest rate method. However, in order to
calculate the effective interest rate, we would need to know the period over which cash flows are
expected from the investment (i.e. the length of the period before the shares are to be redeemed),
being information that has not been provided in the question.
In addition, as this investment is measured at amortised cost, Mpofana must also recognize a loss
allowance reflecting expected credit losses. If the investment is not credit-impaired, the loss
allowance must be measured at 12-month expected credit losses of C11 120. However, if the
investment is considered to be credit-impaired on initial acquisition, the loss allowance should be
measured at lifetime expected credit losses of C23 250. If it is classified at amortised cost (and
assuming it was not considered credit-impaired), the journal entries would be as follows:
Debit Credit
1 January 20X1
FA: Preference shares: AC: GCA (A) FV: 350 000 + TC: 3 500 353 500
Bank 353 500
Recognition of financial asset, classified at amortised cost, initially
measured at FV with transaction costs capitalised.
31 December 20X1
FA: Preference shares: AC: Loss allowance (-A) 11 120
Recognition of 12-month expected credit losses on financial assets
Bank C350 000 x coupon rate: 15% 52 500
Interest income (P/L: I) C353 500 x EIR: x% xxx
FA: Preference shares: AC: GCA (A) Balancing (debit/ credit) xxx
Recognition of interest income at the EIR method and the receipt of
first dividend
For additional information, not part of the required:

If the investment had to be classified at fair value through profit or loss (i.e. to avoid an
accounting mismatch), the investment would be initially measured at its fair value of C350 000
with the transaction costs of C3 500 expensed. The investment will then be remeasured to fair
value at reporting date with fair value gains or losses recognised in profit or loss. The
abovementioned loss allowance would not be recognized. In this case the journal entries would
be as follows:
Debit Credit
1 January 20X1
FA: Preference shares: FVPL (A) Fair value 350 000
Transaction costs (P/L: E) 3 500
Bank 353 500
Recognition of financial asset, classified at FVPL, initially measured
at FV with transaction costs expensed.
31 December 20X1
Bank C350 000 x coupon rate: 15% 52 500
Dividend income (P/L: I) 52 500
Recognition of the receipt of first dividend
FA: Preference shares: FVPL (A) FV: 360 000 – Prior CA: 350 000 10 000
Fair value gain (P/L: I) 10 000
Fair value gain on preference shares at FVPL

Investment in government bonds
The investment in government bonds is held for trading and thus the objective of the business
model being used to manage this investment is referred to as ‘held to sell’. This means the
investment does not meet the criteria to be classified at either:
• amortised cost, because one of the two criteria for this classification is that the objective of
the business model must be to ‘hold to collect the contractual cash flows’; or
• fair value through other comprehensive income, because one of the two criteria for this
classification is that the objective of the business model must be to ‘hold to collect the
contractual cash flows and to sell the investment’.
Since the investment may not be classified at either amortised cost or fair value through other
comprehensive income, it must be classified at fair value through profit or loss.
The investment will be initially measured at its fair value of C2 240 000 with the transaction
costs of C22 400 being expensed. The investment will then be remeasured to fair value at
reporting date with fair value gains or losses recognised in profit or loss.
The journal entries will be as follows:

Debit Credit
1 January 20X1
FA: Bonds: FVPL (A) 2 240 000

Transaction cost (P/L: E) 22 400
Bank 2 262 400
Recognition of financial asset classified at fair value through profit
or loss, initially measured at FV with transaction costs expensed.
31 December 20X1
Bank C2 240 000 x Coupon rate: 10% 224 000
Recognition of interest income received on the bonds
FA: Bonds: FVPL (A) FV: 2 300 000 – Prior CA: 2 240 000 60 000
Fair value gain on bonds (P/L: I) 60 000
Recognition of fair value movements on the bonds
Investment in ordinary shares
The investment in ordinary shares does not meet the criteria to be classified at amortised cost
(AC) or at fair value through other comprehensive income for debt instruments (FVOCI-debt)
because it is an investment in equity instruments and thus does not offer contractual cash flows
at all (i.e. this investment fails the contractual cash flows test). Thus, this investment must be
classified at fair value through profit or loss unless it is not held for trading and Mpofana makes
an irrevocable election on initial recognition to classify the investment at fair value through
other comprehensive income instead. In this case the equity instruments are held for capital
appreciation and thus this potential election is available to Mpofana.
Assuming that the election is not made and thus that the investment is held at fair value through
profit or loss, it will be initially measured at C2 812 000 and the transaction costs of C28 120
will be expensed. The investment will then be remeasured to fair value at reporting date with
fair value gains or losses recognised in profit or loss. The investment will not be tested for
impairment.

Assuming the investment is classified at fair value through profit or loss, the journal entries
will be as follows:
Debit Credit
1 January 20X1
FA: Shares: FVPL (A) 2 812 000

Transaction cost (P/L: E) 28 120
Bank 2 840 120
Recognition of financial asset, classified at FVPL, initially
measured at fair value with transaction costs expensed
31 December 20X1
Bank xxx
Dividend income (P/L: I) xxx
Recognition of dividend income received on the equity shares
Fair value loss - shares (P/L: E) FV: 2 500 000 – Prior CA: 2 812 000 312 000
FA: shares: FVPL (A) 312 000
Recognition of fair value movements on the equity shares
Assuming that Mpofana elects to classify the investment in shares at fair value through other
comprehensive income then it will be initially measured at its fair value of C2 812 000 with the
transaction costs of C28 120 capitalised to the investment. In other words, the investment will
initially be measured at C2 840 120. The investment will then be remeasured to fair value at
reporting date with fair value gains or losses recognised in other comprehensive income. The
investment will not be tested for impairment.
Note that, even though the shares are classified at fair value through other comprehensive
income, the dividend income received from the shares is still recognized in profit or loss.
If Mpofana elects to classify the investment at fair value through other comprehensive income,
the journal entries will be as follows:
Debit Credit
1 January 20X1
FA: Shares: FVOCI (A) FV: 2 812 000 + Transaction costs: 28 2 840 120
120
Bank 2 840 120
Recognition of financial asset classified at fair value through other
comprehensive income, initially measured at fair value with
transaction costs capitalised.
31 December 20X1
Bank xxx
Dividend income (P/L: I) xxx
Recognition of dividend income received on the equity shares
Fair value loss - shares (OCI) FV: 2 500 000 – Prior CA: 2 840 120 340 120
FA: shares: FVOCI (A) 340 120
Recognition of fair value movements on the equity shares

Solution 21.12
Journals
Debit Credit
1 January 20X5
FA: Debentures: at AC: GCA (A) FV: 100 000 x C5 + 500 000
Bank TCs: 0 500 000
Acquisition of debentures, classified at amortised cost (no transaction
costs mentioned in the question)
FA: Debentures: at AC: Loss allowance (-A) 3 900
Recognition of loss allowance, measured at 12-month expected credit
losses
31 December 20X5
Bank 100 000 x C5 x 10% 50 000
FA: Debentures: at AC: GCA (A) 50 000
FA: Debentures: at AC: GCA (A) GCA bal: 500 000 x 65 407
Interest income (P/L: I) EIR: 13,0813%; or W1 65 407
Interest revenue and coupon interest received for the period
31 December 20X6
Bank 100 000 x C5 x 10% 50 000

FA: Debentures: at AC: Loss allowance (-A) 9 900
Remeasurement of loss allowance to the latest estimate of the 12-
31 December 20X7
Bank 100 000 x C5 x 10% 50 000

FA: Debentures: at AC: Loss allowance (-A) & W2 164 200
Remeasurement of loss allowance to the lifetime expected credit losses
Key: AC = Amortised cost (classification) GCA = Gross carrying amount TC = transaction costs
Please note (for your interest only because the 20X8 journals were not required):
Since, at the end of 20X7, the asset’s credit risk had increased significantly, the loss allowance was
remeasured to ‘lifetime expected credit losses’. However, it also became credit-impaired, and thus the
interest income in 20X8 and 20X9 will continue to be measured using the original effective interest rate
but this rate will now be applied to the amortised cost (GCA – Loss allowance) i.e. instead of applying
this rate to the gross carrying amount. See W3 for your interest.

WORKINGS:
W1: Effective interest rate table (Debentures gross carrying amount account) – prepared on
initial recognition: 2 January 20X5
Opening Interest income at Interest received at Closing

balance effective interest interest rate of balance
rate of 13,0813% 10%
20X5 500 000 65 407 (50 000) 515 407
20X6 515 407 67 422 (50 000) 532 829
20X7 532 829 69 701 (50 000) 552 529
20X8 552 529 72 278 (50 000) 574 808
20X9 574 808 75 192 (650 000) (1) 0
350 000 (850 000)
(1): Interest: 50 000 + Capital (ignoring defaults): 100 000 x (C5 + C1 premium) = 650 000
For your interest: the EIR was calculated as follows:

PV = GCA = 500 000
N=5
PMT = 100 000 x C5 x 10% = 50 000
FV: 100 000 x (C5 + C1) = 600 000
COMPT = 13,08131%
W2: Lifetime expected credit losses on credit-impaired financial asset
On 31 December 20X7, the asset’s credit risk increased significantly. Thus, the loss allowance must now
reflect the asset’s ‘lifetime expected credit losses’. The adjustment to the loss allowance is thus:
Lifetime expected credit losses at 31 December 20X7 Given 178 000
Less previous balance at 12-m expected credit losses at 31 December 20X7 Given (13 800)
Increase in loss allowance to be processed 164 200
Since the asset also became credit-impaired on this date, the interest revenue in future years (20X8 and
20X9) will now be measured using the same original effective interest rate but this rate will now be
applied to the amortised cost of the bonds rather than the gross carrying amount, as was the case in W1.
The amortised cost is the gross carrying amount less the loss allowance. See W3 & W4 below.
P.S. If the asset had not also become credit-impaired on this date (i.e. the credit risk had simply increased
significantly), then the interest revenue in future years (20X8 and 20X9) would continue to be measured
using the same original effective interest rate applied to the gross carrying amount of the bonds.
If you are interested in seeing the workings and journals for 20X8 and 20X9, please see the next 3 pages


WORKINGS & JOURNALS RELATING TO 20X8 AND 20X9 (for your interest only):
In this question, we were simply given the lifetime expected credit losses. However, we must
remember that the lifetime expected credit loss is calculated to reflect the difference between the GCA
and the PV of the remaining expected cash flows, discounted using the original EIR (in this case
13,08131%).
The question did not give us the details regarding the remaining expected cash flows (i.e. the actual
expected cash flows after taking into account the expected cash shortfalls). Instead, the lifetime
expected credit loss was given to us. However, let us imagine that this lifetime expected credit loss
was based on the following expectation regarding the future remaining cash flows, estimated at
31 December 20X7:
• Only 50% of the remaining annual coupon debenture interest was expected to be received
(C25 000 in 20X8 and C25 000 20X9); and
• Only C425 654 was expected on redemption in 20X9 (i.e. instead of C600 000).
Using this detailed information, let us now see how the lifetime expected credit loss of C178 000
was calculated (W3) and see what the revised effective interest rate table would look like after it
became credit-impaired (W4).
W3: Lifetime expected credit losses (for your interest)

PV of future cash flows at end 20X7 C
Expected receipt at end 20X8 C25 000 / 1,1308131 22 108
Expected receipt at end 20X9 (C25 000 + C425 654) / 1,1308131 / 1,1308131 352 421
374 529
Lifetime expected credit loss at end 20X7
Gross carrying amount: end 20X7 W1 552 529
PV of future cash flows: end 20X7 Calculation above (374 529)
Lifetime expected credit loss 178 000
W4: Effective interest rate table (Debentures), reflecting ‘GCA balances’ until they become
credit-impaired on 31 Dec 20X7, after which it reflects ‘Amortised Cost balances’ – this table
would be prepared after realising the asset had becoming credit-impaired: on 31/12/20X7 (for
your interest)
Opening Interest income at Interest received at Closing

balance effective interest interest rate of balance
rate of 13,08131% 10%
20X5 500 000 65 407 (50 000) 515 407
20X6 515 407 67 422 (50 000) 532 829
20X7 532 829 69 701 (50 000) 552 529
Loss allowance (given – or see W3) (178 000)
Revised closing balance (W3) 374 529
20X8 374 529 48 993 (25 000) 398 522
(1)
20X9 398 522 52 132 (450 654) 0
303 655 (625 654)
(1): Interest: 25 000 + Capital (net of loss): 425 654 = 450 654
Notice: After this asset becomes assessed as having become credit-impaired, the interest in 20X8 and
20X9 is based on:
• the amortised cost rather than the GCA and thus the interest is based on C374 529 (not on C552 529)
(notice that the opening and closing balances in the above table initially reflected the gross carrying
amount in 20X5, 20X6 and 20X7, but then at the end of 20X7, the loss allowance of C178 000 was
deducted, and thus, from this point onwards, the opening and closing balances in 20X8 and 20X9
reflect the amortised cost); and
• the effective interest rate used remains the same as the original effective interest rate used in W1
(i.e. we do not use a credit-adjusted effective interest rate).

WORKINGS & JOURNALS RELATING TO 20X8 AND 20X9 continued …
Since the interest revenue is now measured based on the amortised cost (rather than on the gross carrying
amount), both the GCA account and the Loss Allowance account will now have to be adjusted for interest
to reflect the unwinding of the effects of discounting (i.e. look at the previous journals and notice that
the Loss Allowance accounts in 20X5, 20X6 and 20X7 were not adjusted for interest but in 20X8 and
20X9 they are adjusted for interest – see journals presented after these workings).
W4.1 (an alternative) Effective interest rate table (Debenture loss allowance account) – drafted
after becoming credit-impaired: on 31 December 20X7 (for your interest)
Please also note that we could continue to use the original effective interest rate table created in W1 (i.e.
the original EIR table that reflected the opening and closing GCAs) and simply create a second effective
interest rate table to show the unwinding of the loss allowance.
Opening Interest income at Recognition of Closing

balance effective interest impairment loss and balance
rate of 13,08131% cash shortfalls
20X5 - - (3 900) (3 900)
20X6 - - (9 900) (13 800)
20X7 - - (164 200) (178 000)
20X8 (178 000) (23 285) 25 000 (176 285)
20X9 (176 285) (23 060) 199 345 -
(46 345) (46 345)
Using the original EIR table showing the unwinding of the financial asset’s GCA (W1), together with
the above EIR showing the unwinding of the loss allowance (W4.1) (from the point at which the asset
becomes credit-impaired), we can extract the interest revenue to be recognised (notice that the interest
revenue is the same as the interest revenue calculated in the EIR table in W4):
20X8: 72 278 (W1) – 23 285 (W4.1) = 48 993
20X9: 75 192 (W1) – 23 060 (W4.1) = 52 132

JOURNALS FOR 20X8 AND 20X9 … FOR YOUR INTEREST
Using the extra information regarding the expected and actual cash flows / shortfalls in 20X8 and 20X9
that was provided in W3, you would then be able to prepare the remaining journals:
Debit Credit
31 December 20X8
Bank Interest received (see extra info given 25 000
in W3)
FA: Debentures: at AC: GCA (A) Amt that should have been received: 50 000
100 000 x C5 x 10% (coupon interest)
FA: Debentures: at AC: Loss allowance (-A) Balancing; or 25 000
Shortfall:
Coupon interest: 50 000 – Int.
received 25 000
EIR: 13,0813%; or W1
FA: Debentures: at AC: Loss allowance (-A) LA bal: 178 000 x 23 285
EIR: 13,0813%; or W4.1
Interest income (P/L: I) Balancing; Or W4; Or 48 993
AC*374 529 x 13,08131%
Interest revenue (48 993) and coupon interest received for the period (only
25 000), reflecting a shortfall of 25 000 (should have received 50 000 but
only received 25 000)
*AC = W4; Or GCA: 552 529 (W1) – LA: 178 000 (W4.1) = 374 529
31 December 20X9
Bank Interest and capital received (see extra 450 654
info given in W3):
25 000 + 425 654
FA: Debentures: at AC: GCA (A) Amt that should have been received: 650 000
100 000 x C5 x 10% (coupon interest)
+ C600 000 (capital)
FA: Debentures: at AC: Loss allowance (-A) Balancing; or 199 346
Shortfall:
Coupon interest & Capital: (50 000 +
600 000) –
Amt actually received: (25 000 +
425 654)
EIR: 13,0813%; or W1
FA: Debentures: at AC: Loss allowance (-A) LA bal: (178 000 + 23 285 – 25 000) x 23 060
EIR: 13,0813%; or W4.1
Interest income (P/L: I) Balancing; Or W4; Or 52 132
AC*398 523 x 13,08131%
Interest revenue (52 132) and coupon interest received for the period (only
25 000) plus capital repayment received (only 425 654), reflecting a shortfall
of 199 346 (should have been 50 000 + 600 000)
*AC = W4; Or 574 808 (W1) – 176 285 (W4.1) = 398 523

Solution 21.13
Debit Credit
1 January 20X6
FA: Bond: AC: GCA (A) Given 694 640
Bank 694 640
Purchase of bond
Impairment loss (P/L: E) Given 16 875
FA: Bond: AC: Loss allowance (-A) 16 875
Loss allowance on bond measured at 12-month expected credit losses
31 December 20X6
FA: Bond: AC: GCA (A) W1: GCA 694 640 x EIR: 10% 69 464
Interest income recognised in P/L at the effective interest rate
Bank Nominal value: 640 000 x CR: 10% 64 000
FA: Bond: AC: GCA (A) 64 000
Receipt of interest at coupon rate
Impairment loss (P/L: E) Latest estimate of 12m ECL: 21 800 – 4 925
FA: Bond: AC: Loss allowance (-A) Previous balance: 16 875 4 925
Remeasurement of loss allowance on bond - remeasured to latest estimate
of 12-month expected credit losses (ECL)
31 December 20X7
FA: Bond: AC: GCA (A) W1: GCA (694 640 + 69 464 – 64 000) x 70 011
Interest income (P/L: I) EIR: 10% 70 011
Interest income recognised in P/L at the effective interest rate
Bank Nominal value: 640 000 x CR: 10% 64 000
FA: Bond: AC: GCA (A) 64 000
Receipt of interest at coupon rate
Impairment loss: FA (P/L: E) Latest estimate of lifetime ECL: 129 075 107 275
(given & W2) – Previous balance: 21
FA: Bond: AC: Loss allowance (-A) 800 107 275
Remeasurement of loss allowance on bond – remeasured to lifetime
expected credit losses following significant increase in credit risk that
resulted in the asset being considered to be credit-impaired
31 December 20X8
GCA o/b: 706 115 (W1 or W4) x EIR:
FA: Bond: AC: GCA (A) 10% 70 612
FA: Bond: AC: Loss allowance (-
A) LA o/b: 129 075 (W5) x EIR: 10% 12 908
Interest income (P/L: I) AC o/b: (706 115 – 129 075) x EIR: 10% 57 704
Interest income recognised in P/L using EIR method – asset now credit-
impaired and thus the interest income is measured by applying the EIR to
the amortised cost (GCA – loss allowance) – both the GCA account and the
loss allowance account must be ‘unwound’ (using the same original EIR)
Note: no coupon payment was received in 20X8
Impairment loss (P/L: E) Latest estimate of lifetime ECL: 180 363 38 380
FA: Bond: AC: Loss allowance (-A) (given & W3) – prior balance: (129 075 +
12 908) 38 380
Remeasurement of loss allowance on bond – remeasured to lifetime
expected credit losses at end 20X8 (note: the prior year balance of 129 075
has been partially unwound during 20X8 – see jnl above)

Debit Credit
31 December 20X9 (not required – for your interest only)
FA: Bond: AC: GCA (A) GCA o/b: 776 727 (W4) x EIR: 10% 77 673
FA: Bond: AC: Loss allowance (-A) LA o/b: 180 363 (W5) x EIR: 10% 18 037
Interest income (P/L: I) AC o/b: (776 727 – 180 363) x EIR: 10% 57 704
Interest income recognised in P/L using EIR method – since the asset
became credit-impaired, the interest income is measured by applying the
EIR to the amortised cost (GCA – loss allowance) – both the GCA account
and the loss allowance account must be ‘unwound’ (using the same original
EIR)
Bank Given: 640 000 + 16 000 656 000

FA: Bond: AC: GCA (A) Bal in this acc: o/b 776 727 + int 77 673 854 400
FA: Bond: AC: Loss allowance (-A) Bal in this acc: o/b 180 363 + int 18 037 198 400
Receipt of the final amount in settlement of the bond
Comment:
• The question did not refer to transaction costs but had these been incurred, they would have been
capitalised to the financial asset account.
• It is assumed that the purchase price equalled the FV on date of acquisition. If it did not equal FV, the
asset would have been measured at FV and a day-one gain or loss would have had to be recognised.
• Notice that no coupon payment was received in 20X8.
• Notice that the interest income is calculated by applying the EIR to:
− The GCA o/b in 20X6 & 20X7 because the asset was not credit-impaired during these periods;
− The AC o/b (GCA – LA) because the asset was credit-impaired during these periods.
• Notice that the loss allowance account is increased in 20X8 due to:
− the unwinding of the discount, recognised as a reduction of the interest income in 20X8, and
− an increase in the expected lifetime expected credit losses to C180 363, recognised as an
impairment loss expense.

WORKINGS:
W1: Effective interest rate table before being assessed as credit-impaired
Opening Interest income Receipts

carrying Closing
amount At EIR of 10% At coupon rate of 10% carrying amount
20X6 694 640 69 464 (64 000) 700 104

20X7 700 104 70 011 (64 000) 706 115
20X8 706 115 70 612 (64 000) 712 727
20X9 712 727 71 273 (64 000) 720 000
(720 000) 0
281 360 (976 000)
W2: Lifetime expected credit losses at 31 December 20X7 (for your interest)
The asset is considered to be credit-impaired at 31 December 20X7 and thus the loss allowance must
now reflect the lifetime expected credit losses at that date.
For your interest: The asset’s lifetime expected credit losses at 31 December 20X7 were given to us at
C129 075. However, for your interest, the lifetime expected credit loss is measured as the difference
between the GCA and the present value of the remaining future expected cash flows, discounted using
the original effective interest rate (i.e. 10%):
GCA at 31 December 20X7 W1 706 115

PV of future cash flows Future cash flows 698 219 x 0.82644 (PV factor for 10%, (577 040)
being the EIR, after 2 years)
129 075
W3: Lifetime expected credit losses at 31 December 20X8 (for your interest)
The asset is still considered to be credit-impaired at 31 December 20X8 although the estimated cash
flows have changed to C656 000 (C640 000 + C16 000).
The asset’s revised lifetime expected credit loss at 31 December 20X8 was given to us at C180 363.
However, for your interest, the lifetime expected credit loss is measured as the difference between the
GCA and the present value of the remaining future expected cash flows, discounted using the original
effective interest rate (i.e. 10%):
GCA at 31 December 20X8 GCA end X7: W1: 706 115 + 706 115 x EIR: 10% - Rec: 0 (W4) 776 727
PV of future cash flows Future cash flows 656 000 x 0.90909 (PV factor for 10%, (596 364)
being the original EIR, after 1 year)
180 363
W4: Effective interest rate table showing actual cash flows – Gross Carrying Amount Account
Opening Interest income Receipts Closing

balance At EIR balance
20X6 694 640 69 464 (64 000) 700 104
20X7 700 104 70 011 (64 000) 706 115
20X8 706 115 70 612 0 776 727
20X9 776 727 77 673 (656 000) 198 400
287 760 (784 000)

WORKINGS continued …
W5: Effective interest rate table – Loss Allowance Account
Opening Interest Impairment loss Closing

balance At EIR Adjustment balance
20X6 0 N/A (21 800) (21 800)
20X7 (21 800) N/A (107 275) (129 075)
20X8 (129 075) (12 908) (38 380) (180 363)
20X9 (180 363) (18 037) N/A (198 400)
(30 945) (167 455)
Notice:
• The asset was credit-impaired at end of 20X7 and 20X8 and thus the LA on these reporting dates
reflect lifetime expected credit losses. The lifetime expected credit losses are measured based on
the present value of the future cash flows, discounted at the original EIR. Thus the LA opening
balance in 20X8 and 20X9 (respectively) must be unwound at the same EIR:
− 20X8: 129 075 x 10% = 12 908
− 20X9: 180 363 x 10% = 18 037
• The LA account is adjusted from one year to the next for changes in the estimated expected credit
losses (recognised as impairment loss expenses or reversals thereof), and if the asset was credit-
impaired, then also for the unwinding of the related discount (recognised as an adjustment to the
interest income).
W6: Effective interest rate table showing net effect of GCA a/c and Loss allowance a/c – Amortised cost
GCA account LA account Amortised cost

Closing Balance (W4) Closing balance (W5) (GCA – LA)
20X6 700 104 (21 800) 678 304
20X7 706 115 (129 075) 577 040
20X8 776 727 (180 363) 596 364
20X9 198 400 (198 400) 0
Notice:
• The net effect of the GCA and LA accounts reflects the amortised cost.
• The asset was credit-impaired at the end of 20X7 and thus the loss allowance was adjusted at end of
20X7 to reflect the lifetime ECLs of C129 075, (calculated as GCA – PV of future cash flows). Thus
the amortised cost at end 20X7 reflects the PV of future cash flows of C577 040 (W2).
• The asset was still credit-impaired at the end of 20X8 and thus the loss allowance was adjusted at
end of 20X8 to reflect the latest estimate of the lifetime ECLs of C180 363, (calculated as GCA –
PV of future cash flows). Thus the amortised cost at end 20X8 reflects the PV of future cash flows
of C596 364 (W3).
Proof that when the asset is credit-impaired, the AC should reflect the PV of future cash flows:
AC = GCA – LA
Where LA = GCA – PV
Therefore, if we substitute ‘GCA – PV’ into the first equation above, we get:
AC = GCA – (GCA – PV)
If we solve this equation, we get:

AC = PV

Solution 21.14
Journals
Debit Credit
1 January 20X5
FA: Bond: at FVOCI (A) Given: FV: 1 519 530+ TC: 0 1 519 530
Bank 1 519 530
Purchase of bond
Impairment loss (P/L: E) Given or W6.2 26 250

Loss allowance reserve (OCI) 26 250
Impairment of financial asset: Loss allowance on bond recognised,
measured at 12-month expected credit losses (no evidence that it was
credit-impaired on initial recognition)
31 December 20X5
Bank Nominal value: 1 400 000 x Coupon rate:

10% 140 000
FA: Bond: at FVOCI (A) Balancing 11 953
Interest income (P/L: I) GCA 1 519 530 x EIR 10%; or W6.1 151 953
Recognising interest income in P/L using EIR method (original EIR
applied to GCA) and recognising interest received
Loss allowance reserve (OCI) Latest estimate 12m ECL: 23 600 – 2 650
Impairment reversed (P/L: I) Previous balance: 26 250; or W6.2 2 650
Impairment of financial asset is partially reversed: Remeasurement of loss
allowance on bond to latest estimate of 12-month expected credit losses
FA: Bond: at FVOCI (A) FV: 1 580 000 – CA: (purchase 1 519 530 + 48 517
FV gain on FA (OCI) movement per EIR method 11 953); or W8 48 517
Remeasuring FA to fair value at year-end; FV gain accumulated in OCI
31 December 20X6
Bank Nominal value: 1 400 000 x Coupon rate: 10% 140 000
FA: Bond: at FVOCI (A) Balancing 13 148
Interest income (P/L: I) GCA (1 519 530 + 11 953) x EIR 10% or W6.1 153 148
Recognising interest income in P/L using EIR method (original EIR
applied to GCA) and recognising interest received
Impairment loss (P/L: E) Latest estimate Lifetime ECL: 242 980 – 219 380
Loss allowance reserve (OCI)Previous balance: 23 600; or W6.2 219 380
Remeasurement of loss allowance on bond to estimated lifetime
expected credit losses, since credit risk increased significantly (no
evidence of credit risk in 20X5 but weak financial health end of 20X6);
results in a further impairment loss expense
FV loss on FA (OCI) FV: 1 200 000 – CA: (o/b 1 580 000 + 393 148
FA: Bond: at FVOCI (A) movement per EIR method 13 148); or W8 393 148
Remeasuring FA to fair value at year-end: FV loss is accumulated in OCI

Journals continued …
Debit Credit
31 December 20X7
FA: Bond: at FVOCI (A) GCA o/b: 1 544 631 x EIR: 10%; or W6.1 154 463
Loss allowance reserve (OCI) LA o/b: 242 980 x EIR: 10%; or W6.2 24 298
AC o/b: (1 544 631 – 242 980) x EIR:
Interest income (P/L: I) 10% 130 165
Interest income recognised in P/L using EIR method (no interest received)
Notice: because the FA is credit-impaired at end 20X6, the interest income
from then on is calculated using the original EIR but applied to the AC o/b
– not to the GCA o/b. This means that the loss allowance reserve, which
now reflects the asset’s lifetime ECL (as the credit risk had increased
significantly), being the PV of all the expected shortfalls, is now also
‘unwound’ as part of this journal.
GCA o/b: (1 519 530 + 11 953 + 13 148) = 1 544 631
Loss allowance reserve (OCI) Latest estimate of lifetime ECL: 235 458 – 31 820
Prior balance: (242 980 + 24 298); or
Impairment loss reversed (P/L: I) W6.2 31 820
Remeasurement of loss allowance on bond to latest estimate of lifetime
ECLs (although the asset was ‘recovering’, there is no evidence that it is
not still considered to be credit-impaired); this results in an impairment
loss reversal
FV loss on FA (OCI) FV: 1 280 000 – CA: (o/b: 1 200 000 + 74 463
movement per EIR method 154 463); or
FA: Bond: at FVOCI (A) W8 74 463
Remeasuring FA to fair value at year-end – FV loss accumulated in OCI
31 December 20X8 (not required – for your interest only)
FA: Bond: at FVOCI (A) GCA o/b: 1 699 094 x EIR: 10%; or W6.1 169 910
Loss allowance reserve
(OCI) LA o/b: 235 458 x EIR: 10%; or W6.2 23 546
Interest income (P/L: I) AC o/b: (1 699 094 – 235 458) x EIR: 10% 146 364
Interest income recognised in P/L using EIR method (no interest received)
(because asset is credit-impaired at end 20X7, the interest income in 20X8
is measured using the original EIR applied to the AC o/b – not to the GCA
o/b; which also means that the loss allowance is now also unwound)
GCA o/b: (1 519 530 + 11 953 + 13 148 + 154 463) = 1 699 094
FA: Bond: at FVOCI (A) FV: (1 575 000 + 35 000) – CA: (o/b 160 090
FV gain on FA (OCI) 1 280 000 + movement per EIR method 160 090
169 910) ; or W8
Remeasuring FA to fair value at year-end; the FV on this date will reflect
the actual expected cash flows of 1 610 000 (expected coupon: 35 000 +
expected redemption amount: 1 575 000); this results in a FV gain
accumulated in OCI
Bank Given: 1 575 000 + 35 000 1 610 000

FA: Bond: at FVOCI (A) o/b 1 280 000 + 169 910 + 160 090; or FV 1 610 000
Loss allowance reserve (OCI) o/b: 235 458 + 23 546; or W6.2 259 004
FV loss on FA (OCI) 48 517 – 393 148 – 74 463 + 160 090; or W8 259 004
Redemption of the bond and reversal of the loss allowance reserve in OCI
against the net FV loss accumulated in OCI


Comment:
• Since these bonds are debt instruments that are managed with the objective of collecting both the
contractual cash flows (principal & interest) and from the sale thereof, they are classified at FVOCI.
• Classifying the bonds at FVOCI means that:
− they are first measured as if they were classified at amortised cost and then remeasured to FV with
FV gains or losses recognised in OCI.
− although impairment testing is the same as for financial assets at amortised cost, and any impairment
losses would also be recognised in P/L, the contra entry for an impairment loss is not a credit to the
financial asset loss allowance account but to a separate loss allowance account in OCI. See IFRS 9.5.5.2


WORKINGS
The following are detailed workings showing how, chronologically, the EIR tables would continually
change and how the lifetime expected credit losses were calculated at the end of 31 December 20X6
and 20X7. The only workings that were necessary include W6 and W8.
W1: Effective interest rate table before becoming credit-impaired

balance At EIR of 10% balance
20X5 1 519 530 151 953 (140 000) 1 531 483
20X6 1 531 483 153 148 (140 000) 1 544 631
20X7 1 544 631 154 463 (140 000) 1 559 094
(1)
20X8 1 559 094 155 909 (1 715 000) 3*
615 476 (2 135 000)
(1): 140 000 + 1 575 000 = 1 715 000 *: Rounding error
W2: Lifetime expected credit losses at 31 December 20X6 (this calculation is for your information
as the lifetime ECL were given)
The asset is considered to have become credit-impaired at 31 December 20X6 and thus the loss allowance
must be remeasured to reflect the lifetime ECLs at that date. The asset’s lifetime ECLs at 31 December
20X6 were given as C242 980. However, for interest, the lifetime ECL is measured as the difference
between the GCA and the present value of the remaining future expected cash flows, discounted using
the original effective interest rate (i.e. 10%):
GCA at 31 December 20X6 W1 1 544 632
PV of future cash flows Future cash flows 1 575 000 x 0.826446 (PV factor for 10%, (1 301 652)
being the original EIR, after 2 years) (no further payments were
expected)
242 980
W3: Effective interest rate tables for both the GCA account and LA account at 31 December 20X6
Since the asset was considered credit-impaired at 31/12/20X6, it means that, from the beginning of 20X7,
the interest income is calculated on the amortised cost (GCA – LA). An EIRT has thus been created for
each of the GCA account and the LA account. The following EIR Table for the:
• GCA account is based on predictions at 31 December 20X6 and reflects the actual expected cash
flows from 20X7 onwards. Notice that the closing balance is C294 004 (the PV of this amount, at
31/12/20X6, is C242 980, being the lifetime ECL, based on the predictions at 31/12/20X6).
• for the LA account, based on predictions at 31 December 20X6, starts with the PV of the total cash
shortfalls and notice that it also ends up with a closing balance of C294 004.
W3.1: EIR Table: Gross carrying amount (GCA) at 31 December 20X6

20X5 1 519 530 151 953 (140 000) 1 531 483
20X6 1 531 483 153 148 (140 000) 1 544 631
20X7 1 544 631 154 463 0 1 699 094
20X8 1 699 094 169 910 (1 575 000) 294 004
629 474 (1 855 000) Debit balance
W3.2: EIR Table: Loss allowance (LA) at 31 December 20X6

Opening Interest expense Impairment loss adjustment Closing
20X5 0 N/A (23 600) (23 600)
20X6 (23 600) N/A (219 380) (242 980)
20X7 (242 980) (24 298) 0 (267 278)
20X8 (267 278) (26 726) 0 (294 004)
(51 024) (242 980) Credit balance

W4: Lifetime expected credit losses at 31 December 20X7 (this calculation is for your information as
the lifetime ECL were given)
The asset is still considered to be credit-impaired at 31 December 20X7 although the estimated cash
flows have increased slightly to C1 610 000 (C1 575 000 + C35 000 – both expected at 31/12/20X8).
The asset’s revised lifetime expected credit loss at 31 December 20X7 was given to us at C235 458.
However, for your interest, this lifetime expected credit loss was measured as the difference between the
GCA and the present value of the remaining future expected cash flows, discounted using the original
effective interest rate (i.e. 10%):
GCA at 31 December 20X7 GCA end X7: W3: 1 544 632 + 1 544 632 x EIR: 10% - Rec: 0 1 699 094
(W4)
PV of future cash flows Future cash flows 1 610 000 x 0.90909 (PV factor for 10%, (1 463 636)
being the original EIR, after 1 year)
235 458
Since the asset was still considered credit-impaired at 31/12/20X7, it means that, from the beginning of
20X8, the interest income is calculated on the amortised cost (GCA – LA). An EIRT has thus been
created for each of the GCA account and the LA account. Thus, the following EIR Table:
• for the GCA account is based on predictions at 31 December 20X7 and reflects the actual expected
cash flows from 20X8 onwards. Notice that the closing balance is C259 004 (the PV of this amount,
at 31 December 20X7, is C235 458, being the lifetime expected credit loss, based on the predictions
at 31 December 20X7).
• for the LA account, based on predictions at 31 December 20X7, starts with the PV of the total cash
shortfalls and notice that it also ends up with a closing balance of C259 005 (same closing balance
as the GCA account).
W5.1: EIR Table: Gross carrying amount (GCA) at 31 December 20X7

20X5 1 519 530 151 953 (140 000) 1 531 483
20X6 1 531 483 153 148 (140 000) 1 544 631
20X7 1 544 631 154 463 0 1 699 094
20X8 1 699 094 169 910 (1 610 000) 259 004
629 474 (1 890 000) Debit balance
W5.2: EIR Table: Loss allowance (LA) at 31 December 20X7
Opening Interest expense Impairment loss adjustment Closing

20X5 0 N/A (23 600) (23 600)
20X6 (23 600) N/A (219 380) (242 980)
20X7 (242 980) (24 298) 31 819 (235 459)
20X8 (235 459) (23 545) 0 (259 004)
(47 843) (211 161) Credit balance
Continued on the next page…


W6.1: EIR Table: Gross carrying amount account (GCA) at 31 December 20X8
20X5 1 519 530 151 953 (140 000) 1 531 483
20X6 1 531 483 153 148 (140 000) 1 544 631
20X7 1 544 631 154 463 0 1 699 094
20X8 1 699 094 169 910 (1 610 000) 259 004
629 474 (1 890 000)
W6.2: EIR Table: Loss allowance account (LA) at 31 December 20X8
Opening Interest expense Impairment loss Closing
balance At EIR of 10% Adjustment balance
20X5 0 N/A (23 600) (23 600)
20X6 (23 600) N/A (219 380) (242 980)
20X7 (242 980) (24 298) 31 820 (235 458)
20X8 (235 458) (23 546) N/A (259 004)
(47 844) (211 160)
Notice:
• The asset was credit-impaired at end of 20X6 and 20X7 and thus the LA on these reporting dates
reflect lifetime expected credit losses. The lifetime expected credit losses are measured based on
the present value of the future cash flows, discounted at the original EIR. Thus the LA opening
balance in 20X7 and 20X8 (respectively) must be unwound at the same EIR:
− 20X7: 242 980 x 10% = 24 298
− 20X8: 235 458 x 10% = 23 546
• The LA account is adjusted from one year to the next for changes in the estimated ECLs (recognised
as impairment loss expenses or reversals thereof), and if the asset was credit-impaired, then also for
the unwinding of the related discount (recognised as an adjustment to the interest income).
W7: Effective interest rate table showing net effect of GCA a/c and Loss allowance a/c – Amortised cost
GCA account LA account Amortised cost
Closing balance (W6.1) Closing balance (W6.2) (GCA – LA)
20X5 1 531 483 (23 600) 1 507 883
20X6 1 544 631 (242 980) 1 301 651
20X7 1 699 094 (235 458) 1 463 636
20X8 259 004 (259 004) 0
Notice:
• The net effect of the GCA and LA accounts reflects the amortised cost (AC).
• The asset was credit-impaired at the end of 20X6 and thus the loss allowance was adjusted at end of
20X6 to reflect the lifetime ECLs of C242 980, (calculated as GCA – PV of future cash flows). Thus,
the amortised cost at end 20X6 reflects the PV of future cash flows of C1 301 651 (W2).
• The asset was still credit-impaired at the end of 20X7 and thus the loss allowance was adjusted at
end of 20X7 to reflect the latest estimate of the lifetime ECLs of C235 458, (calculated as GCA –
PV of future cash flows). Thus, the amortised cost at end 20X7 reflects the PV of future cash flows
of C1 463 636 (W4).
Proof that when the asset is credit-impaired, the AC should reflect the PV of future cash flows:
AC = GCA – LA
Where LA = GCA – PV
Therefore, if we substitute ‘GCA – PV’ into the first equation above, we get:
AC = GCA – (GCA – PV)
If we solve this equation, we get:
AC = PV

W8: Fair value adjustments (for your information)
GCA Fair value Accumulated FV gain/loss

c/balance FV gain/ (loss) Adjustment
(W6 / W7) (Given) closing balance required
20X5 1 531 483 1 580 000 48 517 48 517
20X6 1 544 631 1 200 000 (344 631) (393 148)
20X7 1 699 094 1 280 000 (419 094) (74 463)
20X8 1 869 004 (1) 1 610 000 (2)
(257 004) 160 090
Calculations:
(1): See W6 or W7: o/balance 1 699 094 + interest 169 910 = 1 869 004
(2): The fair value at 31 December 20X8, immediately before the receipts of interest and the redemption of the
capital, was not given. However, the fair value on this date would reflect the amounts expected to be received:
Expected redemption amount: 1 575 000 + Expected coupon interest: 35 000 = 1 610 000

Solution 21.15
a) Debentures issued to Maime
BARRIE LIMITED
JOURNALS
Debit Credit
December 20X1 year-end
October 1 Bank 100 000 x C1 x (100% - 5%) 95 000

FL: Debenture: AC (L) 95 000
Issue of debentures classified at amortised cost
December 31 Interest expense (P/L: E) W1: 12 470 x 3/12; or W2 3 117

Debenture interest expense (EIR method)
December 20X2 year-end
March 31 Interest expense (P/L: E) W1: 12 470 x 3/12; or W2 3 118

FL: Debenture: AC (L) 100 000 x C1 x 10% x 6/12 5 000
Bank 5 000
Debenture interest expense and interest payment (EIR
method) – see W1 or W2
September 30 Interest expense (P/L: E) W1: 12 470 x 6/12; or W2 6 235

FL: Debenture: AC (L) 100 000 x C1 x 10% x 6/12 5 000
Bank 5 000
Debenture interest expense and interest payment (EIR
method) – see W1 or W2
December 31 Interest expense (P/L: E) W1: 12 794 x 3/12; or W2 3 198

Debenture interest expense (EIR method)
– see W1 or W2

a) continued …
WORKINGS:
W1: Effective interest rate table - issued debentures
Opening Payments
carrying Interest expense Closing
Year amount at EIR of 13,12608% carrying amount
First year 95 000 12 470 (10 000) 97 470
Second year 97 470 12 794 (10 000) 100 264
Third year 100 264 13 161 (10 000) 103 424
Fourth year 103 424 13 575 (10 000) 107 000
(107 000) 0
52 000 (147 000)
W2: Effective interest rate table - issued debentures – ALTERNATIVE TO W1
O/balance Interest Pmts C/balance
YE closing
to 31 Dec 20X1 95 000 3 117 0 98 117 balance 95 000 x EIR x 3/12
to 31 March 20X2 3 118 (5 000) 96 235 95 000 x EIR x 3/12
to 30 Sept 20X2 6 235 (5 000) 97 470 95 000 x EIR x 6/12
YE closing
to 31 March 20X3 3 199 (5 000) 98 867 97 470 x EIR x 3/12
to 30 Sept 20X3 6 397 (5 000) 100 264 97 470 x EIR x 6/12
YE closing
to 31 March 20X4 3 290 (5 000) 101 844 100 264 x EIR x 3/12
to 30 Sept 20X4 6 580 (5 000) 103 424 100 264 x EIR x 6/12
YE closing
to 31 March 20X5 3 394 (5 000) 105 212 103 424 x EIR x 3/12
to 30 Sept 20X5 6 788 (5 000) 107 000 103 424 x EIR x 6/12
(107 000) 0
52 000 (147 000)
Comment:
The solution assumes that the coupon payment is paid in semi-annual instalments, but that the interest is
only compounded on an annual basis – thus the effective interest has been calculated on the following
basis:
PV = 95 000
PMT = 100 000 x 10%
FV = 100 000 x (1+7%) = 107 000
N =4
COMP I = 13.12608%
If you were not provided the effective interest rate and the solution did not specify the compounding
period, the effective interest rate could have been calculated using 8 periods and a semi-annual instalment
of C5 000.

b) Debentures issued to Darling
BARRIE LIMITED
JOURNALS
Debit Credit
2 January 20X5
Bank 1 000 000 x C4 4 000 000
FL: Debenture: FVPL (L) 4 000 000
Issue of debentures classified at fair value through profit or loss (FVPL)
31 December 20X5
Interest expense (P/L: E) 1 000 000 x C5 x 10% 500 000
Bank (A) 500 000
Interest expense incurred and paid
Fair value loss (P/L: E) W4: FV loss due to change in market risk 989 512
Fair value gain reserve (OCI) W4: FV gain due to change in credit risk 431 166
FL: Debentures: FVPL (L) W4: total change in FV: 558 346
FV at YE: 4 558 346 – FV at beginning of
current year: 4 000 000
Remeasurement of debentures to fair value at year-end
Barrie designated the debentures at FVPL to avoid an accounting
mismatch: where a liability has been designated as at FVPL, the portion of
any FV gain/loss that arises due to changes in credit risk (as opposed to
changes in market risk) must be recognised in OCI (instead of P/L)

b) continued…
WORKINGS:
W1: Effective interest rate table – debentures (not required, included for informative purposes)
Opening Interest expense Interest paid

balance 19.992737% 10% Debenture liability
YE 31/12/20X5 4 000 000 799 709 (500 000) 4 299 709
YE 31/12/20X6 4 299 709 859 630 (500 000) 4 659 339
YE 31/12/20X7 4 659 339 931 529 (500 000) 5 090 868
YE 31/12/20X8 5 090 868 1 017 804 (500 000) 5 608 672
YE 31/12/20X9 5 608 672 1 121 327 (500 000) 6 229 999
1 (6 230 000) 0
4 730 000 (8 730 000)
Note:
To calculate the effective interest rate on a financial calculator, use the following inputs:
FV = Redemption of 1 000 000 debentures x C6.23 = -6 230 000
PV = 4 000 000
N = 5 years
PMT = - 500 000
I = Comp = 19.992737%
W2: Fair value of debentures at 31/12/X5: excluding the effects of credit rating downgrade

N = 4 years
PMT = - 500 000
Comp = 15%
PV = Comp = 4 989 512
W3: Fair value of debentures at 31/12/X5: including the effects of credit rating downgrade

N = 4 years
PMT = - 500 000
Comp = 18%
PV = Comp = 4 558 396
W4: Fair value movements

Fair Value
2 January 20X5 4 000 000
Fair value loss (P/L) 989 512
Fair value 31/12/X5 (excluding effects of credit rating) (W2) 4 989 512
Fair value gain (OCI) (431 116)
Fair value 31/12/X5 (including effects of credit rating) (W3) 4 558 396
Comment: This is a basic question illustrating the accounting treatment of a financial liability designated
at fair value through profit or loss.
• Notice how the total fair value adjustment (a loss of C558 396) has been split between the portion
that relates to market conditions (a loss of C989 512) and the portion that relates to the deterioration
of Barrie’s credit rating (a gain of C431 116).
• Notice how the increase in Barrie’s credit risk lead to a gain. Clearly this is counter-intuitive (i.e. a
decreased credit rating reflects negatively on Barrie’s cash flow management, which logically should
not result in a gain). Since it does not make sense to reflect a gain due to the deteriorating credit risk,
we recognise it in OCI (instead of profit or loss), so as to avoid distorting Barrie’s profit or loss.


c) Disclosure: statement of comprehensive income and statement of financial position
BARRIE LIMITED
STATEMENT OF COMPREHENSIVE INCOME (EXTRACT)
FOR THE YEAR ENDED 31 DECEMBER 20X5
20X5 20X4
C C
Profit subtotal xxx xxx
Fair value loss 20X5: Darling: part (b): jnls or W4 (989 512) 0
Finance costs 20X4: (529 033) (32 151)
Maime: part (a): W2: 3 290 + 6 580 + 3 394 +
Wendy: part (c): W1: 18 887
20X5:
Maime: part (a): W2: 3 394 + 6 788 +
Wendy: part (c): W1: 18 851 +
Darling: part (b): jnls: 500 000
Profit before tax xxx xxx
Tax xxx xxx
Profit for the year xxx xxx
Other comprehensive income
- Fair value gain 20X5: Darling: part (b): jnls or W4 431 116 0
Profit for the period xxx xxx


c) continued…
BARRIE LIMITED
STATEMENT OF FINANCIAL POSITION (EXTRACT)
AT 31 DECEMBER 20X5
20X5 20X4
Non-current liabilities C C
Redeemable debentures: issued 20X1 Maime: Part (a): W2 & comment 1 0 0
Redeemable debentures: issued 20X3 Wendy: Part (c): W1 & comment 2: 163 470 163 858
(balance at the end of the next year)
Redeemable debentures: issued 20X5 Darling: Part (b): W4 & comment 4 058 396 0
3:
20X5: 4 558 396 – 500 000
Current liabilities
Redeemable debentures: issued 20X1 Maime: Part (a): W2 & comment 1 0 106 818
Redeemable debentures: issued 20X3 Wendy: Part (c): W1 & comment 2: 389 349
20X4: 164 207 – 163 858
20X5: 163 858 – 163 469
Redeemable debentures: issued 20X5 Darling: Part (b): W4 & comment 500 000 0
3: interest pmt
Comment:
Please note how the non-current and current portions of the debenture liabilities have been presented
separately. This is done in order to comply with IAS 1.
1) The Maime debentures closing balance in 20X4 is presented in its entirety as a current liability due to the
fact that this entire balance is due within 12-months of reporting date – the debentures were redeemed on 30
September 20X5. C106 818 is thus disclosed under current liabilities. There is no closing balance in 20X5
since the Maine debentures were redeemed during the 20X5 financial year.
2) The Wendy debentures will be redeemed on 31 December 20Y2 (a period in excess of 12-months from both
31 December 20X4 and 20X5). Only a portion of the closing balance in 20X4 (C164 207) is payable within
12-months. Similarly, only a portion of the closing balance in 20X5 (C163 858) is payable within 12-months.
These current portions are calculated by subtracting the interest that will be incurred in the following
financial year from the payment to be made in that same period. Thus:
• current portion of 20X4 c/balance = coupon pmt 20X5: C19 200 – interest exp 20X5: 18 851 =
C349, and
• current portion of 20X5 c/balance = coupon pmt 20X6: C19 200 – interest exp 20X6: C18 811 =
C389.
3) There is no closing balance for the Darling debentures in 20X4 since they were only issued in 20X5.
Since the Darling debentures are designated at FVPL, the interest expense thereon is not recognised
in P/L using the EIR method. Thus, the current portion of these debentures at the end of 20X5 is
simply the coupon payment due within 12 months of reporting date (i.e. due in 20X6).


WORKINGS:
W1: Wendy Debentures effective interest rate table – debentures

Interest expense Payments Liability
Date Effective interest Nominal interest Closing Balance
(11,48029%) (160 000 x 12%)
01/01/X3 80 000 x C2.06 164 800
31/12/X3 18 920 (19 200) 164 520
31/12/X4 18 887 (19 200) 164 207
31/12/X5 18 851 (19 200) 163 858
31/12/X6 18 811 (19 200) 163 469
31/12/X7 18 767 (19 200) 163 036
31/12/X8 18 717 (19 200) 162 554
31/12/X9 18 662 (19 200) 162 015
31/12/Y0 18 600 (19 200) 161 415
31/12/Y1 18 531 (19 200) 160 746
31/12/Y2 80 000 x C2 18 454 (19 200) 160 000
(160 000) 0
187 200 (352 000)

Solution 21.16
Journals
Debit Credit
1 January 20X1
Bank 600 000 x C12 7 200 000
FL: Debentures: AC (L) W2 2 518 363
Equity: Debenture (Eq) W3 (balancing) 4 681 637
Issue of debentures – compound FI – with the financial liability
classified at amortised cost (there is no evidence that it was held
for trading and thus we assume it would not meet the criteria to be
classified at FVPL and we are told it was not designated at FVPL)
31 December 20X1
Interest expense P/L: (E) W4 402 938
FL: Debenture: AC (L) Balancing 497 062
Bank (A) W1 900 000
Interest expense and interest payment for the period
31 December 20X2
Interest expense (P/L: E) W4 323 408
Bank (A) W1 900 000
31 December 20X3
FL: Debentures: AC (L) Balancing 668 847
Bank (A) W1 900 000
31 December 20X4
Bank (A) W1 900 000
Interest expense and interest payment for the period (debentures
are now ordinary shares – represented by the 4 681 637, which
was journalised on issue of the debentures)
Equity: Debenture (Eq) 4 681 637

Ordinary shares (Eq) 4 681 637
600 000 debentures converted into 600 000 ordinary shares
(compulsory conversion of the debentures into ordinary shares on
a 1 for 1 basis)
Comment:
• This question involves a compound financial instrument since the entity has an obligation to pay
interest on the debentures for 4 years (liability component) but instead of returning the principal, it
will convert the debentures into ordinary shares (equity component).
• The liability component is measured first and the equity component is measured as the residual
amount. This is known as the ‘residual value’ approach in IAS 32, and is also known as ‘splitting
the compound’.
• The liability is initially measured at the present value of the future obligation (see W2) because it is
classified at amortised cost. Notice how the liability gets reduced using the effective interest rate
method until it has a nil balance on conversion date (W4).
• The liability component is classified at amortised cost because there is no evidence that it was held
for trading and thus we assume it would not meet the criteria to be classified at FVPL and we are
told it was not designated at FVPL.

WORKINGS:
W1: Debenture interest paid per annum
= 600 000 x C10 (face value) x 15%

= 900 000
W2: Present value of liability (using the 16% discount rate given)
Discount factor Cash payment (W1) Present value of cash payment

0,862069 (1) 900 000 775 862
0,743163 (2) 900 000 668 847
0,640658 (3) 900 000 576 592
0,552291 (4) 900 000 497 062
3 600 000 2 518 363
(1) 1 / 1.16 (2) 0.862069 / 1.16 (3) 0.743163 / 1.16 (4) 0.640658 / 1.16
The calculation of the PV of the liability can also be shown as follows:

= (900 000 / 1.16) + (900 000 / 1.162) + (900 000 / 1.163) + (900 000 / 1.164)
= 2 518 363
Or
The PV of the liability can also be calculated using a financial calculator:
n = 4 FV = 0 PMT = 900 000 I = 16% Comp PV = 2 518 363
W3: Equity portion
Cash received 600 000 x C12 7 200 000

Present value of liability W2 (2 518 363)
Equity (balancing) 4 681 637
W4: Effective interest rate table
Interest
Opening Interest expense paid Closing
balance at 16% at 15% balance
31 December 20X1 2 518 363 402 938 (900 000) 2 021 301
31 December 20X2 2 021 301 323 408 (900 000) 1 444 709
31 December 20X3 1 444 709 231 153 (900 000) 775 862
31 December 20X4 775 862 124 138 (900 000) 0
1 081 637 (3 600 000)

Solution 21.17
a) Journal entries
Debit Credit
1 January 20X4
Bank (A) 200 000 x C3,50 700 000
Financial liability: preference shares (L) 700 000
Issue of 200 000 10% cumulative redeemable preference shares at C3,50
31 December 20X4
Interest on preference shares
Financial liability: preference shares (L) 200 000 x C3,50 x 10% 70 000
Bank (A) 70 000
Preference dividend paid
31 December 20X5
Bank (A) 70 000
31 December 20X6
Bank (A) 70 000
31 December 20X7
Bank (A) / Preference shareholders for dividends (L) 70 000
.
Financial liability: preference shares (L) 200 000 x (C3,50 + C0,50) 800 000
Bank (A) 800 000
Redemption of preference shares at a premium of C0,50 (compulsory
redemption)
Comment: When measuring a FL at AC, the redemption and dividend is absorbed into the calculation of
the interest expense.


a) Continued…
WORKINGS
W1: Effective interest rate table: Redeemable preference shares
Interest Liability
12.94787715% Bank Preference shares
01 January 20X4 700 000
31 December 20X4 90 635 (70 000) 720 635
31 December 20X5 93 307 (70 000) 743 942
31 December 20X6 96 325 (70 000) 770 267
31 December 20X7 99 733 (70 000) 800 000
380 000 (280 000)
b) Recognition of preference shares redeemable at option of the shareholder
If the preference shares are redeemable at the option of the shareholder (i.e. instead of being
compulsorily redeemable), the answer would remain the same as above.
This is because both types of cash outflows relating to the preference shares still meet the
definition of a financial liability:
• the dividend remains non–discretionary, thus the issuing entity’s obligation to deliver this
cash is unavoidable; and
• the redemption of the preference shares is at the option of the shareholder, thus the issuing
entity does not have an unconditional right to avoid the delivery of this cash.
Thus, the preference shares are recognised as a pure liability because, in the case of both the
dividend and the redemption, the issuing entity does not have the unconditional right to avoid
the related cash outflows. See IAS 32.19

c) Journal entries
Debit Credit
1 January 20X4
Bank (A) 200 000 x C3,50 700 000
Issue of 200 000 10% cumulative redeemable preference shares at C3,50
31 December 20X4
Bank (A) 70 000
Loss on fair value of preference share (P/L: E) 200 000 x FV: C3,80 – FL bal: 130 000
Financial liability: preference shares (L) (200 000 x C3.50– 70 000) 130 000
Measurement of preference share liability at FV
31 December 20X5
Bank (A) 70 000
Financial liability: preference shares (L) (200 000 x C3.80 – C70 000) 90 000
31 December 20X6
Bank (A) 70 000
31 December 20X7
Bank (A) 70 000
Financial liability: preference shares (L) 200 000 x (C3,50 + 800 000
Bank (A) premium C0.50) 800 000
Payment for the redemption of the preference shares C4 (incl. a premium of
C0.50)

Solution 21.18
Debit Credit
30 November 20X7
Financial assets: Loan to Farmland (A) 1 300 000
Bank 1 300 000
Loan advanced to Farmland
31 December 20X7
Bank 7 583
Finance income for the period
31 December 20X8
Bank 81 250
Interest income (P/L: I) W1: 42 250 + 39 000 81 250
Finance income for the period
Bank 3 250
Interest rate swap gain (P/L: I) W2 3 250
Settlement of interest rate swap
W1: Interest income
Note: Interest income is earned from 30 November 20X7 onwards, as this is the date the loan is granted.
Thus, interest income for 20X7 is earned only in December 20X7.
JIBAR Balance Calculations Interest income

+1%(%)
December 20X7 7.0 1 300 000 7%/12 x C1 300 00 7 583
1 January 20X8 - 6.5 1 300 000 6.5%/12 x 6 months x C1 300 000 42 250
30 June 20X8
1 July 20X8 – 6.0 1 300 000 6.0%/12 x 6 months x C1 300 39000

31 December 000
20X8
WORKINGS:
W1: Interest rate swap cash flows
Variable rate payment: 42 250 (W2) + 39 000 (W2) = 81 250
Fixed rate received: C1 300 000 x 6.5% = 84 500
Gain = Variable rate payment – Fixed rate received = 81 250 – 84 500 = 3 250

Solution 21.19
a) FVPL to AC
Debit Credit
31 December 20X6
Financial assets: preference shares (A) 250 000 x (2.92-2.60) 80 000

Gain on preference shares (P/L: I) 80 000
Fair value gain on preference shares
Bank W2 60 000
Preference share income (P/L: I) 60 000
Finance income and coupon receipt for the period
1 January 20X7
Financial asset at amortised cost (bonds) 730 000

Financial asset at fair value 730 000
Reclassification of preference shares from FV to amortised cost

Loss allowance on financial asset (-A) 2 750
Recognition of 12-month expected credit losses on preference shares
31 December 20X7
Bank 60 000
Financial asset: preference shares 9 545
Interest income: preference shares 69 545
Interest income on preference shares at amortised cost
Loss allowance on financial asset (-A) 50

Impairment loss reversal (P/L: I) 2 750 – 2 700 50
Recognition of decrease in 12-month expected credit losses on
preference shares
WORKINGS:
W1: Portfolio A: Effective interest rate table:

Effective interest Interest Balance
at 9.527% received
1 January 20X7 730 000
31 December 20X7 69 545 (60 000) 739 545
31 December 20X8 70 455 (60 000) 750 000
W2: Bonds: Effective interest rate
N=2
PV = -(C2.92 x 250 000) = -730 000
PMT = (C2.4 x 250 000 x 10%) = 60 000
FV = (C3 x 250 000) = 750 000
Comp I = 9.527%

b) FVPL to FVOCI
Debit Credit
1 January 20X4 (Not required)
Financial assets: preference shares (A) 250 000 shares x issue price C2.40 600 000
Bank (A) 600 000
Acquisition of preference shares
31 December 20X4 (N/A: insufficient information provided)
31 December 20X5 (N/A: insufficient information provided)
31 December 20X6
Financial assets: preference shares (A) 250 000 x (FV at CY reporting 80 000
Gain on preference shares (P/L: I) date 2.92 – FV at PY reporting 80 000
date 2.60)
Fair value gain on preference shares
Bank (A) 60 000

Preference share income (P/L): I 60 000
1 January 20X7
Financial asset at FV through OCI (A) 730 000
Financial asset at FV through P/L 730 000
(A)
Reclassification of preference shares to FV through OCI
Impairment loss (E) 2 750

Expected credit loss reserve (OCI) 2 750
Reclassification of loss allowance to OCI
31 December 20X7
Bank 60 000
Financial asset: preference shares 9 545
Interest income: preference shares 69 545
Loss allowance on financial asset (-A) 50

Impairment loss reversal (P/L: I) 2 750 – 2 700 50
Recognition of decrease in 12-month expected credit losses on preference
shares
Financial asset: preference shares (C3.10 x 250 000) – 739 545 35 455
(W1)
Fair value gain (OCI) 35 455

WORKINGS:
W1: Portfolio A: Effective interest rate table:

Effective interest Interest Balance
at 9.527% received
1 January 20X7 730 000
31 December 20X7 69 545 (60 000) 739 545
31 December 20X8 70 455 (60 000) 750 000
W2: Bonds: Effective interest rate
N=2
PV = -730 000
PMT = 60 000
FV = 750 000
Comp I = 9.527%

Solution 21.20
a)
IFRS 7 lists the risks associated with financial instruments as follows:

⚫ Market risk, which is made up of three distinct risks:
− Currency risk
− Interest rate risk; and
− Other price risk
⚫ Credit risk
⚫ Liquidity risk
b)
Blues Ltd is exposed to almost all of the abovementioned financial risks. Each of the risks to
which it is exposed is discussed below.
Market Risk:
⚫ Currency risk:
Currency risk is defined as: the risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in foreign exchange rates.
Since Blues Limited buys its machinery and raw materials from Country Limited, a
company based in the USA, it has a debt that is dollar denominated. Since Blues Limited
is based in South Africa, this means that Blues Limited is exposed to the risk that the debt
payable increases due to changes in the currency exchange rates. The exchange rate on the
date that goods are purchased (transaction date) will differ from the rate available on the
date that the creditor is paid (settlement date).
Although Blues Limited sells to both local and foreign customers, the trial balance indicates
that a significant portion of the sales are constituted by sales to customers based in London
(Great Britain). If the sales are denominated in Pounds (i.e. the foreign currency as opposed
to the local currency of Rands), the amounts receivable from the sales will be variable based
on the exchange rate ruling on the date of settlement. The measurement of the sales income
will be dependent on the exchange rate ruling when the sale is made (transaction date) and
the amount of cash that will be received will depend on the exchange rate ruling on the date
the debtor settles the debt (settlement date).
• Interest rate risk:
Interest rate risk is defined as: the risk that the fair value or future cash flows of a
financial instrument will fluctuate because of changes in market interest rates.
Blues Limited has fixed rate debentures and is thus exposed to interest rate risk (e.g. if the
market rates decrease, Blues Limited will unfortunately continue to pay at the high fixed
rate and the fair value thereof will increase). Since the loan is at a variable interest rate, it
is not exposed to interest rate risk (the fair value will move with the market rate changes).

Solution 21.20 continued…
b) continued …
• Other price risk:
Other price risk is defined as the risk that the fair value or future cash flows of a financial
instrument will fluctuate because of changes in market prices (other than those arising
from interest rate and currency risk). E.g. an increase in the share price of shares to be
purchased.
This risk is not applicable to Blues Limited.
Credit risk:
Credit risk is defined as the risk that one party to a financial instrument will cause a financial
loss for the other party by failing to discharge an obligation.
Blues Limited is exposed to credit risk as it offers 60 days credit to all customers worldwide.
These debtors may be unable to pay Blues within the 60 days, or indefinitely, and Blues is
therefore exposed to credit risk.
Liquidity risk:
Liquidity risk is defined as the risk that an entity will encounter difficulty in meeting obligations
associated with financial liabilities.
Blues Limited is exposed to this risk as they have:

⚫ A substantial loan with variable interest rates, where an increase in the interest rate may
make it difficult to repay interest and capital
⚫ A substantial trade payable, which is compounded by the fact that it is denominated in a
foreign currency, which means that the amount owing could increase with a change in the
exchange rate.
Blues Limited offers credit to all of its customers and will therefore have an irregular cash flow,
with cash from a sale being delayed for up to 60 days. This will obviously compound its
liquidity risk.

c)
Blues Limited should be able to mitigate these risks as follows:
How Blues Limited may limit its currency risk
The exposure to fluctuating exchange rates may be reduced through:

⚫ forward exchange contracts,
⚫ currency swaps,
⚫ futures for either buying or selling in different currencies, or
⚫ internal matching, whereby the value of Blues Limited’s exports substantially equal the
value of its imports thus offsetting its risks.
How Blues Limited may limit its interest rate risk
The exposure to fluctuating interest rates may be reduced through:

⚫ internal matching of interest rates (e.g. lending at variable rates as well as borrowing at
variable rates),
⚫ interest rate swaps,
⚫ options to swap interest rates, and
⚫ forward rate agreements.
How Blues Limited may limit its credit risk
The exposure to credit risk can be reduced by:

⚫ limiting the value of credit given to customers;
⚫ implementing stricter collection policies (e.g. sending frequent statements and reminders
to customers),
⚫ ensuring the quality of debtors by performing a credit review before granting credit to
customers, (thus reducing potential bad debts levels).
How Blues Limited may limit its liquidity risk
Its exposure to liquidity risk can be reduced by:

⚫ reducing current assets and converting them to cash, for example:
− encouraging payment on transaction date (increase cash sales);
− implementing credit terms that will result in the debtors settling as soon as possible
(high interest on late payments), or
− reducing inventory levels (by increasing sales) or purchasing and manufacturing
inventory on a ‘demand basis’.
This will increase available cash resources that can be used to remove debts and release money
for other investments that may currently be tied up in working capital.
Comment:
This question offered an in-depth discussion of the financial risks outlined in IFRS 7 and typical
‘real world’ responses to these risks.

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GAAP: Graded Questions Financial instruments – general principles

There are certain aspects of the definition that are missing:

A financial asset is defined as:

© Service & Kolitz, 2022-2023 Chapter 21: Page 1

Solution 21.1 continued...

Conclusion: Investments in convertible debentures will always be classified at fair value

© Service & Kolitz, 2022-2023 Chapter 21: Page 2

Solution 21.1 continued...

A financial liability is defined as:

© Service & Kolitz, 2022-2023 Chapter 21: Page 3

Solution 21.1 continued...

The process of identifying whether an asset is required to be impaired is a requirement of IAS

© Service & Kolitz, 2022-2023 Chapter 21: Page 4

Solution 21.1 continued...

A decision to classify a financial asset at FVOCI-equity on initial recognition is an irrevocable

Financial liabilities may never be reclassified.

© Service & Kolitz, 2022-2023 Chapter 21: Page 5

Classification and initial measurement of the 5 investments

Classification of the 5 investments:

Investment in equity instruments

General theory relating to the classification of equity instruments

The investment in unlisted shares

The investment in listed shares

© Service & Kolitz, 2022-2023 Chapter 21: Page 6

Solution 21.2 continued …

The investment in shares in subsidiary companies

Investment in debt instruments

General theory relating to the classification of debt instruments

© Service & Kolitz, 2022-2023 Chapter 21: Page 7

Solution 21.2 continued …

The investment in government bonds

Investment in convertible debentures

Investment in corporate bonds

Initial measurement of financial assets:

General theory relating to the initial measurement of financial assets

Classification Initial measurement:

© Service & Kolitz, 2022-2023 Chapter 21: Page 8

Solution 21.2 continued …

Investment Classification Calculations/ comments Initial

Listed shares FVPL At FV (transaction costs expensed) C2 112 000

Shares in subsidiary Two options possible:

Government bonds AC FV: 1 144 000 + Transaction costs: 16 1 160 500

Convertible debentures FVPL At FV (transaction costs expensed) C4 928 000

Corporate bonds FVPL At FV (transaction costs expensed) C6 877 200

© Service & Kolitz, 2022-2023 Chapter 21: Page 9

Financial assets can be classified as at:

The classification is determined based on two criteria:

The financial asset is classified as an amortised cost financial asset if:

© Service & Kolitz, 2022-2023 Chapter 21: Page 10

Solution 21.3 continued …

Portfolio 1: Government bonds

The first portfolio, classified as amortised cost, will be measured as follows:

Portfolio 2: Equity Instruments

Movements in fair value are recognised in other comprehensive income.

© Service & Kolitz, 2022-2023 Chapter 21: Page 11

Solution 21.3 continued …

31 December 20X7 Debit Credit

Bank 900 000