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- 6 Marks
Question
Chereponi Ltd (Chereponi) is a listed manufacturing company. Chereponi granted a loan of GH¢25 million to a homeless charity for the building of a community centre. The loan was granted on 1 January 2018 and is repayable on maturity in four years’ time. Interest, which is subsidized, is to be charged one year in arrears at 4%, but Chereponi assesses that a normal rate for such a loan would have been 8%. Chereponi recorded a financial asset at GH¢25 million and reduced this by the interest received each year.
Required:
In accordance with IFRS 9: Financial Instruments, recommend with justification the required accounting treatment for the issue of the loan to the homeless charity in the financial statements of Chereponi for the year ended 31 December 2018. (6 marks)
Answer
The fair value of the bond is determined by calculating the present value of all future cash receipts using the prevailing market interest rate for a similar financial instrument. This will result in a lower figure than the amount advanced. The difference is recognised in profit or loss.
Cash flows and present value calculation:
| Year | Cash Flow (GH¢m) | Discount Factor @ 8% | Present Value (GH¢m) |
|---|---|---|---|
| 2017 | 1 | 0.93 | 0.93 |
| 2018 | 1 | 0.86 | 0.86 |
| 2019 | 1 | 0.79 | 0.79 |
| 2020 | 26 | 0.74 | 19.24 |
Total Present Value: 21.82 GH¢ million
Accounting treatment:
- The fair value of the loan is calculated by scheduling the cash flows due to take place over the life of the loan and discounting them to present value at the unsubsidised rate of interest of 8%.
- The making of the loan should have been accounted for as:
| Debit | Amount (GH¢m) |
|---|---|
| Financial Asset | 21.8 |
| Profit or Loss | 3.2 |
| Credit | Amount (GH¢m) |
|---|---|
| Cash | 25 |
The asset is then held at amortised cost.
At 1 January 2017:
Interest rate 8%, Cash received GH¢1 million
| Financial Asset | Debit (GH¢m) |
|---|---|
| 21.8 | 1.7 |
Correcting entries in the financial statements for 2018:
| Debit | Amount (GH¢m) |
|---|---|
| SPLOCI | 3.2 |
| Financial Asset | 1.7 |
| Credit (Financial Asset) | 3.2 |
| SPLOCI (Profit or Loss) | 1.7 |
- Tags: Charity, Financial instruments, IFRS 9, Loan
- Level: Level 3
- Uploader: Joseph