Ask AI on The Internet
Question: "QUESTION 1 (40 marks) (72 Minutes) Good Juice Ltd (Good Juice), is a company that produces cold-pressed juices and is based in Cape Town, Western Cape. It has a 30 September year end and has experienced growth over the past two years despite lockdown restrictions. The following transactions took place in the current financial year. Debentures On 1 October 2020, Good Juice issued 2 200 convertible debentures at their fair value of R1 000 each. The debentures have a face value of R1 000 and bear a fixed coupon interest rate of 9% per annum, compounded annually. The coupon interest is payable annually in arrears on 30 September. The debentures are convertible at the option of Good Juice on 30 September 2025, at a ratio of one ordinary share for every debenture held. Any debentures which are not converted on 30 September 2025 will be redeemed at their face value on the same date. A market related interest rate for similar debentures without a conversion option is 11,5% per annum compounded annually. The financial accountant of Good Juice was unsure as to how to account for these debentures, and thus the only journal entry processed to account for the debentures was as follows:" Dr Cr 1 October 2020 R R Bank (SFP) 2 200 000 Debenture liability (SFP) 2 200 000 Proceeds received from the issue of debentures "Discuss, in terms of IAS 32, Financial Instruments: Presentation, the correct classification and initial measurement of the convertible debentures issued by Good Juice on 1 October 2020. Your discussion must include all relevant calculations. Communication skills – logical argument"
Classification IAS 32 requires that a reporting entity identify the separate components of a financial instrument for the purposes of classification namely, equity and liability. Because of the nature of the debenture agreement, Good Juice does not have the unconditional right to avoid making the annual coupon payments/interest and thus has an obligation to make the fixed coupon payments on an annual basis. With regards to the principle (capital) portion of the debentures, Good Juice has an unconditional right to avoid paying cash as the company can choose to issue shares, in settlement of debentures, or may pay cash to redeem the debentures. The conversion rights grant Good Juice the right to issue a fixed number of shares for a fixed redemption value and represent equity. The coupon payment represents a financial liability and the conversion option are equity instruments and form part of the equity component of the debentures. Therefore, the debentures are a compound financial instrument. Initial measurement: The fair value of the convertible debentures as a whole must be determined. This amount is R2 200 000 for the 2 200 debentures (2 200 x R1 000). The next step is to determine the fair value of the financial liability component of the debentures. The liability must be initially measured at the fair value of debentures without the conversion option (as the conversion option is an equity instrument). (IAS 32.32)) The fair value of the liability portion is determined as follows using a financial calculator: N = 5 I = 11.5% PMT = R2 200 000 x 9% = R198 000 FV = 0 Compute PV = R722 675.81 The liability component of the debentures will be measured at its fair value of R722 676. The final step is to subtract the fair value of the liability from the fair value of the instrument as a whole to determine the equity portion. Thus, the equity portion must be initially measured at the residual of R1 477 324 (R2 200 000 – R722 676
According to IAS 32, Financial Instruments: Presentation, financial assets and liabilities must be classified into categories based on the purpose for which they were acquired. The convertible debentures issued by Good Juice on 1 October 2020 should be classified as financial liabilities. This is because the funds received from the sale of the debentures are liabilities of the company and therefore must be recorded as a financial liability. The initial measurement of the debentures should be determined by the fair value of the debentures at the time of issuance. The fair value of the debentures is the market price that would have been received at the time of issuance, net of any transaction costs. As the debentures are convertible at the option of Good Juice on 30 September 2025, the fair value must also take into account the conversion option at the time of issuance. The fair value of the debentures should be calculated by discounting the future cash flows from the debenture at the market related rate of interest for similar debentures without a conversion option, which is 11,5% per annum compounded annually. In this case, the fair value of the debentures should be calculated as follows: Face Value of Debenture x (1 + Interest Rate)5 − Conversion Option Value = R1 000 x (1 + 11.5%)5 − 0 = R1 000 x 1.67101 − 0 = R1 671.01 The fair value of the debentures is then R1 671.01 per debenture. Thus, when Good Juice issues 2 200 debentures, the total fair value of the debentures should be recorded as R3 722 202 (2 200 x R1 671.01). Therefore, the journal entry to account for the issuance of the debentures should be as follows: Dr Cr Bank (SFP) 3 722 202 Debenture liability (SFP) 3 722 202 Proceeds received from the issue of debentures 3 722 202
Feb. 6, 2023, 10:37 a.m.
A new large language model has been made available since this question was asked.
To generate an updated answer from the new model, click the button below.
Think your answer is better than the AI's? Post it below.
Question Tags
If you want your question answered by an AI, click here.
Post your own comment: