LEARNING UNIT NUMBER 1

TITLE OF LEARNING UNIT The Conceptual Framework for Financial Reporting;

Presentation of Financial Statements;
Income Taxes;
Accounting Policies, Changes in Accounting Estimates and
Errors;
Financial Instruments;
The Effects of Changes in Foreign Exchange Rates

NOTIONAL STUDY HOURS 30

NUMBER OF PLANNED SELF- 3 Examples; 7 Questions; 1 Case study

REFLECTIVE ACTIVITIES
NUMBER OF ASSESSMENT 1 (Test 1/2024)
LINKED ACTIVITIES

1.1 Introduction

Within learning unit 1 we will discuss the following individual topics:

Topic IFRS Standard Description

1.1 The Conceptual Framework for financial reporting

1.2 IAS 1, IFRIC 17 Presentation of Financial Statements
1.3 IAS 12, FRP 1, IFRIC 23 Income Taxes
1.4 IAS 8 Accounting Policies, Changes in Accounting Estimates and
Errors
1.5 IAS 32, IFRS 7, IFRS 9, Financial Instruments
IFRIC 19
1.6 IAS 21 The Effects of Changes in Foreign Exchange Rates
The above will be discussed as individual topics within this learning unit.

1.2 Purpose of learning unit

Students should be able to:

• Apply financial reporting in integrated case studies as set out in the Conceptual Framework for
IFRS.
• Assess the recognition and derecognition criteria of an element as specified in the relevant IFRS
in an integrated case study.
• Evaluate the measurement basis that is applicable to an element as guided by the relevant IFRS
in an integrated case study.
• Prepare and discuss general purpose financial statements, including consolidated financial
statements, in accordance with IFRS.

1.3 Assessment criteria

• Interrogate integrated case studies to evaluate the Conceptual Framework for IFRS.
• Recognise an item that is an asset, a liability, equity, income, or expense for inclusion in the
financial statements.
• Derecognise from the financial statements an item that is no longer an asset, a liability, equity,
income or expense.
• Interpret the recognition and/or derecognition of an asset, a liability, equity, income, or expense

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 in a given scenario against the applicable IFRS.
• Assess the measurement basis for an asset or a liability in a given scenario against the
requirements of the applicable IFRS.
• Propose improvements to the measurement basis for an asset or a liability based on the
requirements of the applicable IFRS.
• Compile the general financial statements, including consolidated financial statements, in
accordance with IFRS.
• Assess the appropriateness of disclosures of financial information in relation to general purpose
and consolidated financial statements, prepared in accordance with IFRS.

1.4 How to approach each learning unit

• Please read the prescribed study material for each topic in the learning unit thoroughly before
studying the additional information.
• Study the overview of the individual topic – we have included an overview for each individual topic.
• Answer the examples/questions in the individual topic, if applicable, and make sure you
understand the principles contained in the questions.
• Consider whether you have achieved the exit level outcomes (refer to learning unit 0).
• After you have completed all the individual topics in the learning units, answer the integrated
questions to test whether you have mastered the contents of this learning unit.
• You will be assessed in test 1 on the contents of this learning unit.

Discussion forum

A general discussion forum has been set up for each topic within this
learning unit. It is strongly recommended that you post your questions and
comments on the forum as you work through the learning unit. Your
lecturers are more than happy to assist you on your learning journey.

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 TOPIC 1.1
THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING
INTRODUCTION

The Conceptual Framework for Financial Reporting (Conceptual Framework) describes the
objective of, and the concepts for, general purpose financial reporting. The Conceptual
Framework is not a standard. Nothing in the Conceptual Framework overrides any
Standard or any requirement in a Standard.

PRESCRIBED STUDY MATERIAL

The Conceptual Framework for Financial Reporting

SAICA Student Handbook 2022/2023; Volume1; Part A1; pages A19 to A95

The Conceptual Framework for Financial Reporting was covered as part of your
undergraduate studies. It is important that you revise the study material and concepts if
you are not familiar with the content.

Also, note that Unisa follows the limited open-book policy as prescribed by SAICA and that
you will be allowed to use the SAICA Student Handbook during assessments.

Let’s look at the overview of the Conceptual Framework for Financial Reporting.

3
 Overview of the Conceptual Framework

Chapter 1
Objective of general purpose financial Chapter 2
reporting Qualitative characteristics of useful financial
information
Introduction.
Objective, usefulness and limitations of general Introduction.
purpose financial reporting. The qualitative characteristics of useful
Information about the reporting entity’s economic information.
resources, claims against the entity and changes in The fundamental qualitative characteristics are:
resources and claims. • Relevance
• Economic resources and claims. • Faithful representation
• Changes in economic resources and claims. • Applying the fundamental qualitative characteristics
The enhancing qualitative characteristics are:
• Financial performance reflected by accrual
• Comparability
accounting. • Verifiability
• Financial performance reflected by past cash • Timeliness
flows. • Understandability
• Changes in economic resources and claims not • Applying the enhancing characteristics
resulting from financial performance. The cost constraint on useful financial reporting.
Information about use if the entity’s economic
resources.

Chapter 3 Chapter 5
Financial statements and the reporting entity Recognition and Derecognition
Financial statements:
• Objective and scope of financial statements. The recognition process.
• Reporting period. Recognition criteria - An asset or liability is recognised
• Perspective adopted in financial statements. only if recognition will provide users of financial
• Going concern assumption. statements with information that is useful, i.e. with:
The reporting entity. • Relevant information;
• Consolidated and unconsolidated financial • Faithful representation of the asset or liability
statements. Derecognition.

Chapter 6
Chapter 4: Elements of the financial statements
Introduction.
Measurement bases:
• Historical cost.
Introduction.
• Fair value.
Definition of an asset
• Value in use and fulfilment value.
An asset is a present resource controlled by the
• Current cost.
entity as a result of past events.
Information provided by particular measurement
An economic resource is a right that has the
bases
potential to produce economic benefits.
• Historical cost.
This section discusses three aspects of the
• Fair value.
definition:
• Value in use and fulfilment value.
• Right.
• Current cost.
• Potential to produce economic benefits.
Factors to consider when selecting a measurement
• Control.
basis.
Measurement of equity.
Cash flow-based measurement techniques.

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Definition of a liability Chapter 7: Presentation and Disclosure
• A present obligation of the entity to transfer an
Presentation and disclosure as communication tools.
economic resource as result of past events.
Presentation and disclosure objectives and
For a liability to exist, three criteria must be
principles.
satisfied:
Classification.
• Obligation.
Aggregation.
• Transfer of an economic resource.
• Present obligation as a result of past events

Assets and Liabilities Chapter 8: Capital

• Unit of account.
Concepts of capital.
• Executory contract.
Concepts of capital maintenance.
• Substance of contractual rights and contractual
Capital maintenance adjustments.
obligations.

Definition of equity
• The residual interest in the asset of the entity
after deducting all its liabilities

Definition of income and expenses

• Income is increases in assets or decreases in
liabilities that result in increases in equity other
than those relating to contributions from holders
of equity claims.
• Expenses are decreases in assets or increases
in liabilities that result in decreases in equity
other than those relating to distributions to
holders of equity claims.

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 TOPIC 1.2 – PRESENTATION OF FINANCIAL STATEMENTS
INTRODUCTION

The objective of this Standard is to provide guidelines for the structure and content of
general-purpose financial statements, as well as to explain certain underlying principles.

PRESCRIBED STUDY MATERIAL

IAS 1 Presentation of Financial Statements

SAICA Student Handbook 2022/2023; Volume1; Part A2; pages A1160 to A1208

IAS 1 was covered as part of your undergraduate studies. It is important that you revise
the study material and concepts if you are not familiar with the content.

Also note that Unisa follows the limited open-book policy as prescribed by SAICA and that
you will be allowed to use the SAICA Student Handbook during assessments.

Let’s look at the overview of IAS 1 Presentation of Financial Statements.

6
 Overview of IAS 1 Presentation of Financial Statements

PRESENTATION OF FINANCIAL STATEMENTS

Purpose of Prescribes the basis for preparation of general-purpose financial statements. Sets
out minimum requirements for presentation as well as guidelines for structure and
IAS 1 content of financial statements.

Objective of To provide useful information about the financial position, financial performance
financial and cash flows of an entity to a wide range of users for making economic
statements decisions.

Complete set of
financial Structure and content
statements

▪ Certain line items should be presented on the face of the SFP (e.g. property, plant
and equipment, inventories, provisions, etc.).
Statement of ▪ Certain information should be presented either on the face of the SFP or in the notes
financial (e.g. sub-classifications of line items and details regarding share capital).
position (SFP)
▪ Assets and liabilities should be presented as either current or non-current,
unless presentation is based on liquidity.

▪ All income and expense items recognised in a period are presented as either:
– a single statement of profit or loss and other comprehensive income; OR
– two separate statements (one displaying profit or loss and the other displaying
other comprehensive income together with profit or loss as an opening amount).
▪ Expenditure items should be classified either by their function or their nature.
▪ Specific line items are required to be presented in the profit or loss section (e.g.
revenue, finance cost, tax expense, share of profit of associates and joint ventures,
etc.).
Statement of profit ▪ The nature and amount of material items to be presented either on the face of the
or loss and other SPLOCI or separately in the notes.
comprehensive ▪ Other comprehensive income items to be classified as either:
income
(SPLOCI) – items that will not be classified subsequently to profit or loss; OR
– items that will subsequently be reclassified to profit or loss.
▪ Items of other comprehensive income must be presented as either:
– net of related tax effects; OR
– before related tax effects, with one amount shown for the aggregate amount of
income tax relating to those items.
▪ Reclassification adjustments relating to components of other comprehensive
income need to be disclosed, either on the face, or in the notes.
▪ The notion of extraordinary items has been abandoned.

▪ Reconciliation of equity at the beginning of the reporting period with equity at the
end of the reporting period.
▪ Includes:
– total comprehensive income for the period, separated between amounts
Statement of attributable to the owners of the parent and non-controlling interests;
changes in equity – effect of retrospective restatements; and
– transactions with owners in their capacity as owners (e.g. issue of shares,
dividends paid).
▪ Dividends paid and the related dividends per share should be presented either on
the face, or in the notes.

Statement of cash ▪ Refer to learning unit 6.

flows

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 ▪ Basis of preparation of the financial statements.
▪ Specific accounting policies applied.
▪ Present information required by IFRS not already presented elsewhere.
Notes ▪ Supporting information for items presented in the financial statements.
▪ Additional information on items not presented in the financial statements.
▪ Sources of estimation uncertainty.
▪ Disclosures regarding capital.

▪ Fair presentation and compliance with IFRSs.

▪ Financial statements are prepared on the going concern assumption.
▪ Items recognised on the accrual basis (i.e. when items satisfy the definitions and
recognition criteria of the Conceptual Framework for Financial Reporting).
General ▪ Materiality and aggregation (present each material class of similar items
features for the separately).
presentation of ▪ Offsetting (not allowed unless required/permitted by an IFRS).
financial ▪ Frequency of reporting (at least annually).
statements ▪ Comparative information (in respect of preceding period for all amounts presented
and for the beginning of the earliest period presented where prior year numbers
have been restated).
▪ Consistency of presentation (retain presentation and classification between
periods).

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 TOPIC 1.3 – INCOME TAXES

INTRODUCTION
Taxation represents an unavoidable expense for most entities. Apart from various income
taxes that include all domestic and foreign taxes, it is also necessary to account for deferred
taxation. Deferred tax represents tax that will be paid/saved in future periods when the
carrying amounts of the assets/liabilities are recovered/settled.

PRESCRIBED STUDY MATERIAL

1. IAS 12 Income Taxes

2. FRP 1 Substantively enacted tax rates and tax laws
3. The following document is excluded:
SIC 25 Income taxes – Changes in the tax status of an entity or its shareholders

SAICA Student Handbook 2022/2023; Volume1; Part A2; pages A1309 to A1359

IAS 12 and FRP 1 were covered as part of your undergraduate studies. It is important that
you revise the study material and concepts if you are not familiar with the content.

Also note that Unisa follows the limited open-book policy as prescribed by SAICA and that
you will be allowed to use the SAICA Student Handbook during assessments.

Let’s look at the overview of IAS 12 Income Taxes.

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 Overview of IAS 12 Income Taxes

CURRENT TAX
Amount of income tax payable on taxable profit for a period based on tax law

Measurement Recognition Dr Cr
R R R
Accounting profit xx Current tax expense xx
Add back: Liability xx
Accounting items xx Tax expense is usually
(e.g. depreciation) in P/L but recognises
Include tax treatment xx tax consequence where
(e.g. tax allowance) the item was
recognised
Taxable profit xx (P/L, OCI, Equity)
Current tax @ 27% xx

DEFERRED TAX
Recovery or settlement of carrying amount of assets and liabilities will make future tax payments larger or smaller than
they would have been if they had no tax consequence
= recognised deferred tax, with limited exceptions
Carrying – Tax base = Temporary
amount difference

Some temporary Taxable Deductible

differences are Deferred tax Deferred tax asset
exempt: liability (to the extent probable that could be utilised)
No deferred tax
(show in tax
reconciliation in the
note)

Measurement Recognition
▪ Tax rate expected to apply when Movement in deferred tax Detailed disclosure
temporary differences reverse; balance usually in P/L, but
▪ based on the manner in which the recognises tax consequence
carrying amount is expected to be where the item was
recovered or settled. recognised (P/L, OCI, Equity)

VIDEOS

Watch the five videos discussing deferred taxation.

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 TOPIC 1.4
ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS

INTRODUCTION

The purpose of this standard is to prescribe criteria for the selection of an accounting policy,
as well as for the accounting treatment and disclosure of changes in accounting policies,
changes in accounting estimates and correction of prior period errors, to ensure consistent
preparation and presentation of financial statements. The standard enhances the
comparability of the entity’s financial statements with previous periods, as well as with
financial statements of other entities.

PRESCRIBED STUDY MATERIAL

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

SAICA Student Handbook 2022/2023; Volume1; Part A2; pages A1268 to A1284

IAS 8 was covered as part of your undergraduate studies. It is important that you revise
the study material and concepts if you are not familiar with the content.

Also note that Unisa follows the limited open-book policy as prescribed by SAICA and that
you will be allowed to use the SAICA Student Handbook during assessments.

Let’s look at the overview of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

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 Overview of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors

Determined by Accounting Standards

Accounting policies Initial decision
and Interpretations.

Application of accounting policy should

If no Standard or Interpretation exists,
be consistent from period to period and
management should apply its judgement.
for all similar transactions.

Accounting policies are only changed

Accounting policy changes must be
if:
applied in terms of the transitional
▪ required by an Accounting Changes in accounting policy should
provisions of a new Accounting
Standard or Interpretation; or be appropriately disclosed.
Standard, or retrospectively
▪ the change will provide more
(all comparative amounts and opening
relevant and
balances, where appropriate).
reliable information.

Changes in estimates should be

Changes are applied prospectively,
appropriately disclosed, including the
Changes in estimates namely current reporting period and
effect of the change on future
future periods (where appropriate).
reporting periods (where appropriate).

Corrections are made retrospectively

as if the error was never made. Corrections must be appropriately
Prior period errors disclosed. Note that only corrections
Restate comparative amounts and of prior period errors are disclosed.
opening balances, where appropriate.

VIDEOS

Watch the video discussing errors and accounting policy.

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 TOPIC 1.5 – FINANCIAL INSTRUMENTS
INTRODUCTION/ PURPOSE

Financial instruments include a wide variety of instruments, including shares, debentures,

receivables, payables and derivative instruments (for example share options and forward
exchange contracts). The accounting treatment and disclosure of financial instruments are
prescribed in three different standards.

PRESCRIBED STUDY MATERIAL

1. IAS 32 Financial Instruments: Presentation

2. IFRS 9 Financial Instruments
3. IFRS 7 Financial Instruments: Disclosure

SAICA Student Handbook 2022/2023; Volume1; Part A2; pages A1618 to A1674
SAICA Student Handbook 2022/2023; Volume1; Part A1; pages A418 to A626
SAICA Student Handbook 2022/2023; Volume1; Part A1; pages A324 to A384

The above standards were covered as part of your undergraduate studies. It is important
that you revise the study material and concepts if you are not familiar with the content.

Also note that Unisa follows the limited open-book policy as prescribed by SAICA and that
you will be allowed to use the SAICA Student Handbook during assessments.

Let’s look at the overview of Financial Instruments.

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 Overview of IAS 32 Financial Instruments: Disclosure and Presentation

Definitions Presentation
Financial instruments Liabilities and equities
Financial assets No contractual obligation to deliver cash or another
Financial liability financial asset
Equity instrument Settlement in the entity’s own equity instrument
- Variable number of its own equity instruments
- Fixed number of its own equity instruments
- Contracts (options) on own equity instruments
Contingent settlement provisions
Compound financial instrument
Treasury shares
Interest, dividends, losses and gains
Offsetting a financial asset and a financial liability

Excluded
The following concepts and topics are excluded
from the syllabus:
Definitions
• Purchased or originated credit-impaired financial
assets
• All definitions relating to hedge accounting
Presentation
• Puttable instruments and obligations arising on
liquidation (par. 16A-16F & 22A)

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 Overview of IFRS 9 Financial Instruments

Definitions Measurement
12-month expected credit losses Initial measurements
Amortised cost Subsequent measurements
Credit impaired financial asset - financial assets
Credit loss - financial liabilities
Derivative Amortised cost
Effective interest rate - Modifications
Expected credit losses - Write offs
Financial liability at FVTPL Impairments
Gross carrying amount of financial asset Recognition of expected credit losses
Held for trading Identify when significant increase in credit risk or
Loss allowance when credit impaired
Modification gair or loss Modified financial assets
Transaction costs Simplified approach
Measurement of expected credit losses
Recognition/Derecognition Reclassification of financial assets
Initial recognition Gains and losses
- First-day gains and losses - Investments in equity instruments
Derecognition of financial assets - Liabilities at FVTPL
Derecognition of financial liability - Assets at FVTOCI
- Exchange of debt instrument

Classification Excluded
Financial assets Definitions
- At amortised cost • Purchased or originated credit impaired (POCI)
- At FVTOCI financial assets
- At FVTPL • All definitions relating to hedge accounting
Financial liabilities Initial recognition
- At FVTPL • Regular way purchase or sale of financial assets
Embedded derivatives (trade date and settlement date accounting).
Reclassification Derecognition of financial assets
• Transfers/continued involvement and applying the
requirements to a part or a whole
Classification of financial liabilities
• Financial guarantee contracts
• Loan commitments
Embedded derivatives (only pertains to liabilities)
Hybrid instruments where the host is not a financial
instrument
Initial measurement
• Regular way purchase or sale of financial assets
(trade date and settlement date accounting).
Impairment
• Purchased or originated credit-impaired financial
assets
Hedge accounting
Application guidance and Illustrative Examples follow
the related levels of the main body in the standard.

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EXAMPLES
Complete the following two comprehensive questions.
QUESTION 1 (60 marks/ 90 minutes)

The financial directors of Blue Ltd (Blue) and Pink Ltd (Pink) requested you to explain to them how the
following financial instruments should be classified in the financial statements of Blue and the financial
statements of Pink in terms of IAS 32 Financial Instruments: Presentation. All the transactions below
occurred during the financial year ended 31 December 20.23.

Transaction 1

On 1 January 20.23 Blue purchased 100 000 shares in Pink. These were acquired at fair value on
transaction date.

Transaction 2

On 1 December 20.23 Blue obtained a short-term loan of R20 000 from Pink and is required to repay
the total loan within 90 days. The loan is still outstanding on 31 December 20.23.

Transaction 3

On 1 December 20.23 Blue obtained a short-term loan of R20 000 from Pink and is required to settle
the total loan within 90 days in as many shares as equal to R20 000. The loan is still outstanding on 31
December 20.23.

Transaction 4

On 1 December 20.23 Blue issued share options to Pink. The share options entitle Pink to purchase
2 000 ordinary shares in Blue at a price of R2 per share.

Transaction 5

On 31 December 20.23 Blue issued 1 000 redeemable cumulative preference shares to Pink at an issue
price of R1 per preference share. The dividend rate is an 8% cumulative preference dividend per annum,
calculated on the issue price. All accumulated (unpaid) dividends will roll up until redemption date. The
redemption of preference shares will take place on 31 December 20.25 at R1,20 per share.

Transaction 6

On 31 December 20.23 Blue issued 1 000 non-redeemable cumulative preference shares to Pink at an
issue price of R1 per preference share. The dividend rate is an 8% cumulative preference dividend per
annum, calculated on the issue price. The payment of a preference dividend is solely at the discretion
of the directors of Blue.

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Transaction 7

On 31 December 20.23 Blue issued 1 000 cumulative compulsory convertible preference shares to Pink
at an issue price of R1 per preference share. On 31 December 20.25, the conversion date, each
preference share will automatically be converted into two ordinary shares. The dividend rate is an 8%
cumulative preference dividend per annum calculated on the issue price. All accumulated (unpaid)
dividends will roll up until the conversion date.

Transaction 8

On 1 January 20.23 Blue issued 500 debentures to Pink. Each debenture will be converted into one
ordinary share on 1 January 20.25 if the revenue of Blue increases by more than 8% per annum. If the
increase in Blue’s revenue is less than 8% per annum, the debentures will be redeemed in cash on 1
January 20.25.

Transaction 9

On 1 January 20.23 Blue has 80 000 ordinary shares in issue which were originally issued at R5 each.
On 1 July 20.23 10 000 of the ordinary shares were bought back from Pink at R6 per share.

REQUIRED

Marks
Provide an explanation to the financial directors of Blue Ltd and Pink Ltd of how the above- 60
mentioned financial instruments should be classified in their respective financial
statements for the year ended 31 December 20.23, in accordance with
IAS 32 Financial instruments: Presentation.

Please note:
• You are not required to include calculations in your explanation.
• Ignore the effect of the time value of money in the scenarios above.
• Ignore any normal income tax implications.
• Ignore any Value Added Tax (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

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QUESTION 1 - Suggested solution

PART A

Transaction 1

Blue’s financial statements (investor):

The investment in shares will be classified as a financial asset, since Blue holds the equity
instrument of another entity (IAS 32.11). (1)

Pink’s financial statements (issuer):

The shares issued will be classified as equity instruments, since it is a contract which
evidences a residual interest in the assets of Pink after deducting its liabilities (IAS 32.11). (1)

Transaction 2

Blue’s financial statements:

A loan payable will be recognised as a financial liability, since Blue has a contractual
obligation to deliver cash to Pink within 90 days (IAS 32.11). (1)

Pink’s financial statements:

A loan receivable will be recognised as a financial asset in the records of Pink, since it
represents a contractual right to receive cash from Blue (IAS 32.11). (1)

Transaction 3

Blue’s financial statements:

In terms of the agreement, Blue has no contractual obligation to deliver cash or another (1)
financial asset to settle the loan.
Blue is, however, required to settle the loan with its own shares (equity instruments). It is
important to note that the fact that Blue is required to deliver its own equity instruments does
not automatically classify the loan as an equity instrument (IAS 32.21). (1)
It is essential to determine the substance of the contract. In other words, is the number of
shares to be issued by Blue in terms of the contract fixed or variable (IAS 32.21). (1)
The amount that Blue needs to settle remains fixed at R20 000. However, the number of shares
that Blue will need to deliver to settle the loan varies (the number of shares issued on delivery
date is dependent on the share price of the ordinary shares). (1)
The contract will, therefore, be settled by delivering a variable number of Blue’s own shares in
exchange for a fixed amount. Accordingly, the loan payable is a financial liability (IAS 32.11). (1)

Pink’s financial statements:

A loan receivable will be recognised as a financial asset, since it meets the definition of a
financial asset (Pink receives an equity instrument from another entity) (IAS 32.11). (1)

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Transaction 4

Blue’s financial statements (issuer):

Blue has no contractual obligation in terms of the option contract to deliver cash or another
financial asset to Pink. (1)
The issued share options, however, give Pink the right to buy a fixed number of Blue’s shares
(2 000 ordinary shares) at a fixed price (R2 per ordinary share) (IAS 32.16 and IAS 32.22). (1)
Accordingly, the share options issued by Blue are equity instruments in accordance with
IAS 32.22. (1)

Pink’s financial statements (holder):

The share options meet the definition of a derivative (IAS 32.AG15 and IFRS 9 Appendix A)
from Pink’s perspective. (1)
The investment in the shares will only be recognised as a financial asset of Pink when the share
options are exercised (IAS 32.AG17). (1)

Transaction 5

Blue’s financial statements (issuer):

Blue should consider the two cash flow streams (components) related to preferences shares
(i.e., the payment of preference dividends and the payment of the principal amount) separately
for classification purposes. (1)

Principal amount
When assessing the substance of the agreement between Blue and Pink, it is clear that Blue
has a contractual obligation to deliver cash to Pink on 31 December 20.25 (the preference
share agreement contains a mandatory redemption feature) (IAS 32.18(a)). (1)
The principal amount is classified as a financial liability. (1)

Dividends
It has to be determined if Blue has a contractual obligation to make dividend payments to
assess if the dividend component of this agreement is equity or a financial liability. (1)
Cumulative dividends accumulate (accrue) if the company does not earn sufficient profits to
declare and pay a preference dividend i.e., if the dividend is not declared in one year it will be
carried forward to successive years. (1)
Since this preference share agreement contains a redemption feature, all accumulated
(unpaid) dividends will roll up until redemption date and will have to be paid on
31 December 20.25 when the preference shares are redeemed. (1)
Therefore, based on the substance of this transaction, Blue has a contractual obligation to
declare and pay all preference dividends on or before 31 December 20.25. (1)
In light of the above the preference dividends are classified as a financial liability. (1)

Conclusion
The preference shares are classified as a financial liability (IAS 32.11 and IAS 32.18a).
Take note that the dividends paid to Pink will be recognised in profit or loss as finance costs (1)
since the classification of the financial instrument determines how the related payment will be
treated in the financial statements. (1)

Pink’s financial statements (holder)

The investment in the preference shares will be classified as a financial asset in the records of
Pink. (1)

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Transaction 6

Blue’s financial statements (issuer):

As with the above transaction, if we evaluate the two cash flow streams related to
preferences shares, we can conclude the following: (1)

Principal amount
Non-redeemable preference shares are preference shares that do not have a maturity date
and will, therefore, not be bought back by the issuer (Blue) (also known as perpetual (1)
preference shares). This feature makes non-redeemable preference shares very similar to
equity. (1)

Dividends
The cumulative dividends accumulate (accrue) if the company does not earn sufficient profits
to declare and pay a preference dividend. (1)
Since the non-redeemable preference shares do not contain a redemption obligation and the
payment of preference dividends are at the directors’ discretion, the preference shares
establish no contractual right to a preference dividend (IAS 32.AG26).
(1)
Accordingly, the preference dividends are similar to ordinary dividends (equity). (1)

Conclusion
Accordingly, the preference shares should be classified as equity instruments. (1)

Pink’s financial statements (holder):

The investment in the preference shares will be classified as a financial asset in the records
of Pink, since it is an equity instrument of another entity.
(1)

Transaction 7

Blue’s financial statements (issuer):

The two cash flow streams (components) related to preferences shares (i.e., the payment
of preference dividends and the payment of the principal amount) are considered separately
for classification as equity or a financial liability (IAS 32.28). (1)

Principal amount
The substance of this agreement between Blue and Pink contains a compulsory conversion
feature that will force Blue to convert the preference shares into ordinary shares on 31
December 20.25. (1)
Therefore, in terms of the agreement, Blue has no contractual obligation to deliver cash or
a financial asset to Pink on the conversion date. (1)
Blue is, however, required deliver its own shares (equity instruments) to Pink on the
conversion date. (1)
The substance of the contract determines that Blue has to deliver a fixed number of ordinary
shares to Pink on the conversion date (20 000 ordinary shares). (1)
In light of the above, the principal amount is classified as an equity instrument. (1)

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Dividends
It has to be determined if Blue has a contractual obligation to make dividend payments to
assess if the dividend component of this agreement is equity or a financial liability. (1)
Since this preference share agreement contains a compulsory conversion feature, all
accumulated (unpaid) dividends will roll up until conversion date and will have to be paid on
31 December 20.25 when the preference shares are converted. (1)
Therefore, based on the substance of this transaction, Blue has a contractual obligation to
declare and pay all preference dividends on or before 31 December 20.25. (1)
In light of the above, the preference dividends are classified as a financial liability. (1)

Conclusion
The preference shares are classified as a compound financial instrument as it contains both
an equity and a liability component (IAS 32.28). (1)
This would lead to a “split accounting” treatment, whereby at issue date the net present value
of the amount payable to Pink will be classified as a liability and the balance of the proceeds
received on issue date will be classified as equity (IAS 32.32). (1)

Pink’s financial statements (holder)

The investment in the preference shares will be classified as a financial asset in the records
of Pink, since it is a contractual right to receive cash or another financial asset. (1)

DISCUSSION

If the convertible preference shares are not compulsory convertible, but convertible at the
option of the holder at any time up to maturity, the preference shares will still be classified
as a compound financial instrument for the following reasons:

• Blue has a contractual obligation to declare and pay all accumulated preference
dividends when Pink exercises its option to convert to ordinary shares (financial liability
component).
• If Pink does not exercise its option to convert to ordinary shares, Blue will have to
redeem the preference shares on 31 December 20.25 (financial liability component).
• Pink has a call option (the right to exchange the preference shares for a fixed number
of ordinary shares) at any time before maturity date (equity component).

Transaction 8

Blue’s financial statements (issuer):

The obligation attached to the debentures (settling in cash or by issuing equity instruments) is
dependent on the occurrence or non-occurrence of uncertain future events. (1)
It has to be determined if the uncertain future event (the rise in future revenue) is within the
control of Blue and Pink. (1)
In terms of IAS 32.25 the issuer’s future revenues are not within the control of the issuer
and the holder. (1)
In light of this, Blue does not have an unconditional right to avoid delivering cash on the
maturity date. (1)
Therefore, the debentures are classified as a financial liability in terms of the contingent
settlement provisions of IAS 32.25. (1)

Pink’s financial statements (holder):

The investment in the debentures will be classified as a financial asset in the records of Pink, (1)
since Pink has a contractual right to receive cash. (1)

21
Transaction 9

Blue’s financial statements:

Blue reacquired its own equity instruments and should classify them as treasury shares (1)
(IAS 32.33).
In terms of South African legislation, the shares reacquired by Blue must be cancelled as (1)
issued share capital.
An amount equal to the initial proceeds of the shares (10 000 x R5 = R50 000) is debited to (1)
the share capital account in Blue’s financial statements. (1)
No gain or loss is recognised in profit or loss on the share buy-back.
The remaining R10 000 (R60 000 – R50 000) is debited to any available equity reserve in
Blue’s financial statements (including retained earnings) (IAS 32.33). (1)

Pink’s financial statements:

Before the share buy-back, the investment in equity instruments is classified by Pink as a
financial asset. The share buy-back transaction is accounted for as a disposal of a financial
asset by Pink. (1)
Total (60)

22
QUESTION 2 (75 marks/ 113 minutes)

During the year ended 28 February 20.23 Fincor Ltd entered into the following transactions:

Transaction 1

On 1 March 20.22 the company acquired an investment in Bamboo Ltd, a listed company, for share
trading purposes. On this date 25 000 ordinary shares were acquired at R12,00 per share. Transaction
costs paid by Fincor Ltd amounted to R1 200. The transaction costs are included in the base cost of the
shares in terms of the Eighth Schedule to the Income Tax Act. On 28 February 20.23 the market value
of the shares was R23,25 per share.

Transaction 2

On 30 June 20.22 Fincor Ltd purchased 15 000 ordinary shares in Brick (Pty) Ltd, an unlisted company,
at R12,00 per share. The shares were purchased as a long-term investment. Costs associated with the
transaction amounted to R1 800 and are included in the base cost of the shares in terms of the Eighth
Schedule to the Income Tax Act. On 28 February 20.23 the shares were valued by the directors at
R13,50 per share.

The management of Fincor (Ltd) irrevocably elected in terms of IFRS 9.5.7.5 to present subsequent
changes in the fair value of the investment in Brick (Pty) Ltd in other comprehensive income.

Transaction 3

On 1 August 20.22 Fincor Ltd disposed of an investment in Dodgeball Ltd at a fair value of R160 000.
The costs related to the disposal of the investment amounted to R1 500. The investment in Dodgeball
Ltd was an investment in equity shares and was not held for share trading purposes. The management
of Fincor Ltd irrevocably elected on initial recognition to designate this investment as a financial asset
at fair value through other comprehensive income in terms of IFRS 9.5.7.5. The carrying amount of the
investment in Dodgeball was R150 000 on 1 March 20.22.

Transaction 4

Convertible debentures amounting to a fair value of R250 000 were issued by Fincor Ltd on
1 March 20.22. The debentures have a nominal value of R2 per debenture and pay interest at 14% per
annum in arrears on 28 February until conversion. The debentures are convertible into ordinary shares
with a nominal value of R2 each, at a ratio of one share for one debenture, at the option of the debenture
holders at any time before 28 February 20.27. The market interest rate for similar instruments without
conversion rights is 16%.

Transaction 5

On 1 September 20.22 Fincor Ltd issued 5 000 compulsory convertible debentures with a face value of
R80 per bond. The debentures are compulsory convertible on 1 September 20.25 into two ordinary
shares for every debenture held. A market related interest rate of 6% on the debentures is payable
annually in arrears. The market interest rate for similar instruments without conversion rights is 8%.

23
Transaction 6

On 1 March 20.22 Fincor Ltd purchased bonds in Pear Ltd at a discount of 10% of the face value when
market interest rates on similar instruments were 16,3493% per annum. The total face value of the
investment in bonds is R200 000. A coupon rate of 12% per annum is payable in arrears on
30 August and 28 February. The bonds will be repaid on 28 February 20.25 at face value. Transaction
costs paid by Fincor Ltd amounted to R2 000. The investment in bonds is held within a business model
with the objective to collect contractual cash flows of interest and principal.

On 1 March 20.22 Fincor Ltd assessed the probability that Pear Ltd might default on payments and
estimated the 12-month expected credit losses on the bonds to be R2 000. On 28 February 20.23 there
was no significant deterioration in the credit quality of Pear Ltd and the 12-month expected credit losses
on the bonds were estimated to be R2 500.

Transaction 7

On 1 March 20.22 Fincor Ltd purchased bonds in Apple Ltd at a discount of 10% of the face value when
market interest rates on similar instruments were 16,3493% per annum. The total face value of the
investment in bonds is R200 000. A coupon rate of 12% per annum is payable in arrears on 30 August
and 28 February. The bonds will be repaid on 28 February 20.25 at face value. Transaction costs paid
by Fincor Ltd amounted to R2 000. The investment in bonds is held within a business model whose
objective is to collect contractual cash flows and sell the bonds. In other words, both collecting
contractual cash flows and selling the debentures are integral to achieving the business model.

On 1 March 20.22 Fincor Ltd assessed the probability that Apple Ltd might default on payments and
estimated the 12-month expected credit losses on the bonds to be R 2 000. At 28 February 20.23 there
was no significant deterioration in the credit quality of Apple Ltd and the 12-month expected credit losses
on the bonds were estimated to be R 2 500. The total investment in bonds was sold at 28 February
20.23 for cash at its fair value of R180 000.

Transaction 8

On 1 March 20.22 Fincor Ltd acquired an investment in listed bonds of Tradex Ltd. Fincor Ltd’s objective
with the investment was to hold the assets in terms of a business model to collect contractual cash flows
of interest and principal. The bonds will mature at the end of four years when the principal amount of
R1 000 000 will be received. The coupon rate is 10% per annum payable in arrears, whereas a market
related interest rate on similar bonds is 11% per annum.

On 1 March 20.22 Fincor Ltd assessed the probability that Tradex Ltd might default on payments and
estimated the 12-month expected credit losses on the bonds to be R2 000. At
28 February 20.23 there has been no significant deterioration in the credit quality of Tradex Ltd and the
12-month expected credit losses on the bonds is estimated to be R2 500 on reporting date.

On 1 September 20.22 Fincor Ltd purchased a large investment banking operation. As a result of the
purchase, Fincor Ltd combined its debt investment with the new banking investment portfolio. The
investment banking portfolio has the objective of collecting contractual cash flows and realising fair value
gains through sale, which is also now the business model of the debt investment portfolio held by Fincor
Ltd. In other words, both collecting contractual cash flows and selling the bonds are integral to achieving
the business model.

24
Transaction 9

Fincor Ltd has a portfolio of trade receivables of R5 430 000 at 28 February 20.23 and only operates in
one geographical region. The trade receivables do not have a significant financing component in
accordance with IFRS 15 Revenue from Contracts with Customers. To determine the expected credit
losses for the trade receivables, Fincor Ltd uses a provision matrix. The provision matrix is based on its
historical observed default rates over the expected life of the trade receivables and is adjusted for
forward-looking estimates. Fincor Ltd uses the following provision matrix:

Current 1-30 days 31-60 days 61-90 days More than

past due past due past due 90 days
past due
Default rate 0,3% 1,1% 3,1% 6% 13%

The age analysis of the trade receivables is as follows:

Gross
carrying
amount
R
Current 4 072 500
1-30 days past due 543 000
31-60 days past due 362 000
61-90 days past due 271 500
More than 90 days past due 181 000
Total 5 430 000

Transaction 10

Fincor Ltd borrowed R98 500 cash from Blair Bank Ltd on 1 March 20.22. The loan is repayable in four
equal instalments of R33 475 at the end of each year.

On 28 February 20.23, after paying the first instalment, Fincor Ltd was able to renegotiate the terms of
the loan payable in order to improve its cash position for the next three years. Fincor Ltd issued 10 000
of its own ordinary shares as full and final settlement of the loan payable. The quoted price (level 1 input)
of one Fincor Ltd share on 28 February 20.23 amounted to R8,00.

Additional information

1. Assume a normal tax rate of 27% and a capital gains tax inclusion rate of 80%.

2. SARS will not allow impairment losses (expected credit losses) on the bonds as a deduction for
income purposes.

3. There are no temporary differences other than those evident from the above-mentioned
information. The deferred tax balance on 1 March 20.22 was Rnil.

4. You may assume that none of the financial assets or financial liabilities (other than those indicated
as such) was designated to a specific category.

25
REQUIRED

Marks
(a) Provide all the journal entries in the records of Fincor Ltd since acquisition or 61
issue date of the financial instrument until 28 February 20.23 for transactions 1
to 8.

Please note:
• Journal narrations are not required.
• Ignore any normal income tax implications.
• Round off all amounts to the nearest rand.
• Round off all calculated effective interest rates to four decimals.
• Your answer must comply with International Financial Reporting Standards
(IFRS).

(b) Provide the journal entries in the records of Fincor Ltd to account for the loss 9
allowance on the trade receivables (transaction 9) for the year ended
28 February 20.23 and the settlement of the loan from Blair Bank Ltd
(transaction 10) on 28 February 20.23.

(c) Calculate the deferred tax balance on 28 February 20.23 of transactions 1 to 3. 5

Please note:
• Round off all amounts to the nearest rand.
• Ignore any Value Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

26
QUESTION 2 - Suggested solution

(a) JOURNAL ENTRIES

Dr Cr
R R
TRANSACTION 1

1 March 20.22
J1 Financial asset at fair value through P/L (SFP)
(25 000 x R12,00) 300 000 (1½)
Transaction costs (P/L) 1 200 (½)
Bank (SFP) 301 200 (½)
Recognise investment and expense transaction costs
28 February 20.23
J2 Financial asset at fair value through P/L (SFP)
[(25 000 x R23,25) – 300 000] 281 250 (1½)
Fair value adjustment (P/L) 281 250 (½)
Remeasure investment to fair value at year end
(4½)

DISCUSSION

This investment in equity instruments is classified as a financial asset at fair value

through P/L. The purpose for the acquisition (i.e., trading or long term) does not
impact on the classification of the financial asset in terms of IFRS 9 (it does,
however, have an impact on the tax rate applied for deferred tax purposes). Take
note transaction costs are expensed and not included in the carrying amount of
the investment in terms of IFRS 9.5.1.1.

TRANSACTION 2 Dr Cr
R R
30 June 20.22
J1 Financial asset at fair value through OCI (SFP) 181 800 (½)
Bank (SFP) [(15 000 x 12,00) + 1 800] (SFP) 181 800 (1½)
Recognise investment and capitalise transaction costs
28 February 20.23
J2 Financial asset at fair value through OCI (SFP)
[(15 000 x 13,50) – 181 800] 20 700 (1½)
Mark-to-market reserve (OCI) 20 700 (½)
Remeasure investment to fair value at year end
(4)

DISCUSSION

This investment is classified as a financial asset at fair value through OCI, since the
management of Fincor (Ltd) made the election in terms of IFRS 9.5.7.5. Take note
that management may only make this election if the investment is in an equity
instrument and if it is not held for trading.

27
 Dr Cr
R R
TRANSACTION 3

1 August 20.22
J1 Financial asset at fair value through OCI (SFP)
(160 000 – 150 000) 10 000 (1)
Mark-to-market reserve (OCI) 10 000 (½)
Remeasurement of investment to fair value on date of
sale
J2 Bank (SFP) (160 000 – 1 500) 158 500 (1)
Selling expenses (P/L) 1 500 (1)
Financial asset at fair value through OCI (SFP) 160 000 (½)
Sale of investment in Dodgeball
(4)

DISCUSSION

The investment is revalued to its new fair value on the selling date (prior to
derecognition). The fair value gains/losses on the investment in Dodgeball are recognised
in other comprehensive income, but the selling expenses are recognised in profit or loss.
The cumulative fair value gains/losses presented in OCI through the mark-to market
reserve may not be transferred to profit/loss on selling date (IFRS 9 B5.7.1). However,
Fincor may transfer the cumulative fair value gains/losses within equity (to retained
earnings for instance) (IFRS 9 B5.7.1).

Dr Cr
R R
TRANSACTION 4

1 March 20.22
J1 Bank (SFP) 250 000 (½)
Liability component of convertible debentures
(SFP) [C1] 233 629 (2)
Equity component of convertible debentures
(SCE) [C1] 16 371 (½)
Recognise the convertible debentures issued
28 February 20.23
J2 Finance costs (P/L) [C1] 37 381 (1)
Bank (SFP) 35 000 (½)
Liability component of convertible debentures (SFP)
[C1] 2 381 (½)
Recognise effective interest and interest paid
(5)

28
CALCULATIONS

C1. Convertible debentures

Calculation of present value of liability component

N = 5 [½]
I = 16% (market interest rate) [½]
PMT = 35 000 (250 000 x 14%) (coupon rate) [½]
FV = 250 000 [½]
PV = 233 629

Financial liability (PV of interest and principal amount) 233 629

Equity component (balancing figure) 16 371 [½]
Proceeds of the debenture issue 250 000

Amortisation table

Opening Effective Interest Closing

balance interest coupon balance
fixed at (gross
16% carrying
amount)
R R R R
Year ended 28 February 20.23 233 629 37 381 (35 000) 236 010 [1½]
[4]

Effective interest can also be calculated with “1 amort” on the HP or SHARP calculator.

DISCUSSION

• From Fincor’s perspective the convertible debentures represent a compound

instrument and comprise two components: a financial liability (a contractual
obligation to deliver cash in the form of interest and principal) and an equity
instrument (option granting the holder the right to convert the debentures into a
fixed number of ordinary shares of Fincor).
• The financial liability component of the convertible debentures is measured at
amortised cost using the effective interest rate method in terms of IFRS 9.
• It should be noted that it is not important which party has the option to convert the
debentures into ordinary shares. The issuer’s obligation to make payments of
interest and principal exists as long as the instrument is not converted (irrespective
of which party holds the option to convert).

29
 Dr Cr
R R
TRANSACTION 5

1 September 20.22
J1 Bank (SFP) (5 000 x R80) 400 000 (½)
Liability component of convertible debentures
(SFP) [C1] 61 850 (2½)
Equity component of convertible debentures
(SCE) [C1] 338 150 (1)
Recognise the convertible debentures issued
28 February 20.23
J2 Finance costs (P/L) [C2] 2 474 (1)
Liability component of convertible debentures (SFP)
(balancing) 2 474 (½)
Recognise effective interest accrued for 20.23
(5½)

CALCULATIONS

C1. Compulsory convertible debentures

Calculation of present value of liability component

N = 3 [½]
I = 8% (market interest rate) [½]
PMT = 24 000 (400 000 x 6%) (coupon rate) [½]
FV = 0 [½]
PV = 61 850
[2]

Financial liability (PV of interest) 61 850

Equity component (balancing figure) 338 150 [1]
Proceeds on the debenture issue (5 000 x R80) 400 000

DISCUSSION

• The substance of this agreement is a compulsory conversion feature that will force
Fincor to convert the convertible debentures into ordinary shares on
1 September 20.25. Therefore, Fincor has no contractual obligation to deliver cash
or a financial asset to debenture holders on conversion date.
• Fincor is, however, required to deliver its own shares (equity instruments) to
debenture holders on conversion date. The substance of the contract determines that
Fincor has to deliver a fixed number of ordinary shares to debenture holders on
conversion date. Accordingly, the principal amount contains an equity instrument.
• Fincor has a contractual obligation to make interest payments up until the conversion
date of the bonds. The future interest payments are a financial liability.
• In light of the above, the convertible debentures are classified as a compound financial
instrument.
• Please take note that since the conversion of the debentures into shares is
compulsory, the liability component of the compound financial instrument is only
represented by the future interest payments.

30
C2. Accrued interest on debentures

Effective interest (61 850 x 8% x 6/12) 2 474 [2]

Dr Cr
R R
TRANSACTION 6

1 March 20.22
J1 Financial asset at amortised cost: bonds (SFP)
(180 000 [C1] + 2 000) 182 000 (3)
Bank (SFP) 182 000 (½)
Recognise investment and capitalise transaction costs
J2 Impairment loss (P/L) 2 000 (1)
Allowance for expected credit losses (SFP)(given) 2 000 (½)
Recognition of 12-month expected credit loss
30 August 20.22
J3 Bank (SFP) [C2] 12 000 (1)
Financial asset at amortised cost: bonds (SFP)
(balancing) 2 457 (½)
Interest income (P/L) [C2] 14 457 (1)
Recognise effective interest income and coupon interest
received
28 February 20.23
J4 Bank (SFP) [C2] 12 000 (1)
Financial asset at amortised cost: bonds (SFP)
(balancing) 2 652 (½)
Interest income (P/L) [C2] 14 652 (1)
Recognise effective interest income and coupon interest
received
J5 Impairment loss (P/L) 500 (1)
Allowance for expected credit losses (SFP)
(2 500 (given) – 2 000 [J2]) 500 (1)
Adjust allowance for expected credit losses
(12)

CALCULATIONS
C1. Present value of financial asset at amortised cost: bonds
N = 6 [½]
I = 16,3493% per annum (set HP on 2 P/Y; SHARP = 16,3493/2 = 8,1747) [½]
PMT = 12 000 (200 000 x 12% x 6/12) [½]
FV = 200 000 [½]
PV = -180 000
[2]

DISCUSSION

• The present value of the investment in bonds is R180 000, which is equal to
the amount paid by Fincor Ltd (R200 000 x 90%).

• The credit risk on the bonds did not increase significantly since initial
recognition and, therefore, an allowance for expected credit losses equal to
12-month expected credit losses is recognised at the reporting date (28
February 20.23).

31
C2. Effective interest rate on financial at amortised cost: bonds after transaction costs were
capitalised

N = 6
PV = -182 000 (180 000 + 2 000) [½]
PMT = 12 000 (200 000 x 12% x 6/12)
FV = 200 000
I = 15,8870% per annum (HP) (SHARP 7.94% for 6 months) [½]

Amortisation table for financial asset at amortised cost: bonds

Gross Effective Interest Gross

carrying interest coupon carrying
amount fixed at amount
Opening 15,8870 Closing
balance % p.a. balance
R R R R
Six months ended 30 August 20.22 182 000 14 457 (12 000) 184 457
Six months ended 28 February 20.23 184 457 14 652 (12 000) 187 109

EXAM TECHNIQUE

The effective interest is 15,8870% per annum. The effective interest rate for six
months is 7,9435% (15,8870% x 6/12). The effective interest income can be
calculated on the gross carrying amount for the six months ended 30 August 20.22
as follows:

• 182 000 x 15,8870% x 6/12 = 14 457;

• 182 000 x 7,9435% = 14 457; or
• using the Amort function.

To save time in the exam or test situation, the student can indicate the calculation of
interest as per the calculations indicated above, instead of writing out an amortisation
schedule which can be time consuming.

Dr Cr
R R
TRANSACTION 7

1 March 20.22
J1 Financial asset at fair value through OCI: bonds (SFP)
(200 000 x 90%) + 2 000 (given)) 182 000 (3)
Bank (SFP) 182 000 (½)
Recognise investment and capitalise transaction costs
J2 Expected credit losses (P/L) 2 000 (1)
Expected credit loss reserve (OCI) 2 0001 (½)
Recognition of 12-month expected credit loss
30 August 20.22
J3 Bank (SFP) (200 000 x 0,12 x 6/12) 12 000 (1)
Financial asset at fair value through OCI: bonds (SFP)
(balancing) 2 457 (½)
Interest income (P/L) [C2 transaction 6] 14 457 (1)
Recognise effective interest income and coupon interest
received

32
 Dr Cr
R R
28 February 20.23
J4 Bank (SFP) [C2] 12 000 (1)
Financial asset at fair value through OCI: bonds
(balancing) (SFP) 2 652 (½)
Interest income (P/L) [C2 transaction 6] 14 652 (1)
Recognise effective interest income and coupon interest
received
J5 Expected credit losses (P/L) (2 500 – 2 000) 500 (1)
Expected credit loss reserve (OCI)
(2 500 – 2 000) 500 (½)
Adjusting of 12-month expected credit loss
J6 Fair value loss (OCI) 7 1092 (1)
Financial asset at fair value through OCI: bonds (SFP)
((182 000 + 2 457 + 2 652) – 180 000 (given)) 7 109 (1)
Recognition of fair value loss on investment
J7 Bank (SFP) 180 000 (1)
Financial asset at fair value through OCI: bonds (SFP) 180 000 (1)
Disposal of investment in bonds
J8 Fair value loss (P/L) [J6] 7 109 (1)
Fair value loss (OCI)
Reclassify fair value loss accumulated in equity to profit 7 109 (1)
or loss
J9 Expected credit loss reserve (OCI) 2 500
Expected credit losses (P/L)
(2 000 [J2] + 500 [J5]) 2 500
Reclassify accumulated impairment amounts in equity to
profit or loss on derecognition
(17½)

DISCUSSION
1 An expected credit loss reserve is recognised in other comprehensive income when
those expected credit losses relate to a financial asset mandatorily measured at fair
value through other comprehensive income (IFRS 9.4.1.2.A).
2 The cumulative fair value gain or loss and the expected credit loss reserve recognised
in equity via other comprehensive income are reclassified to profit or loss when the
financial asset is derecognised.
3 The effective interest income recognised in 20.23 is calculated using the original
effective interest on the gross carrying amount of the bonds. The gross carrying
amount is the amortised cost of a financial asset, before adjusting for any loss
allowance.

33
 Dr Cr
R R
TRANSACTION 8

1 March 20.22
J1 Financial asset at amortised cost (SFP) 968 976 (2)
Bank (SFP) 968 976 (½)
(FV = 1 000 000; N = 4; I = 11%; PMT 100 000)
Initial recognition of investment at fair value (PV)
J2 Impairment loss (P/L) 2 000 (1)
Allowance for expected credit losses (SFP)(given) 2 000 (½)
Recognition of 12-month expected credit loss
28 February 20.23
J3 Bank (SFP) (1 000 000 x 10%) 100 000 (1)
Financial asset at amortised cost (SFP)(balancing) 6 587 (1)
Interest income (P/L) (968 976 [J1] x 11%) 106 587 (1)
Recognition of effective interest income and coupon
interest [J1]
J4 Expected credit losses (P/L) 500 (1)
Allowance for expected credit losses (SFP)
(2 500 (given) – 2 000 [J2]) 500 (½)
Recognition of 12-month expected credit loss
(8½)

DISCUSSION

The change in Fincor’s business model will result in the reclassification of the investment
at amortised cost to fair value through other comprehensive income. The reclassification
will only be effected for accounting purposes on the reclassification date, i.e., the first
day of the reporting period after the change in the business model occurred (in this case
1 March 20.23). Accordingly, the investment in Tradex will not be reclassified during 20.23.
The reclassification will be done on 1 March 20.23 and the journal will be as follows:

Dr Cr
R R

Financial asset at fair value through OCI (SFP) 975 563

Financial asset at amortised cost (SFP) 975 563
(968 976 (J1) + 6 587 (J2))

Immediately after reclassification the investment is adjusted to the fair value of the
investment on the reclassification date. Say the fair value of the investment on
1 March 20.23 was R980 000:
Dr Cr
R R

Investment Tradex at fair value through OCI (SFP) 4 437

Fair value adjustment (OCI) (980 000 – 975 563) 4 437
Allowance for expected credit losses (SFP) 2 500
Expected credit loss reserve (OCI) 2 500

When a financial asset is reclassified out of the amortised cost measurement category and
into fair value through other comprehensive income measurement category, the allowance
for expected credit losses recognised in the statement of financial position should be
derecognised and recognised as an accumulated impairment in other comprehensive
income (IFRS 9.B5.6.1(b)).

34
(b) JOURNAL ENTRIES

Transaction 9 Dr Cr
R R
28 February 20.23
J1 Expected credit loss (P/L) [C1] 69 233 (3)
Loss allowance on trade receivables (SFP) 69 233 (½)
Recognition of lifetime expected credit losses
(3½)

DISCUSSION

In accordance with IFRS 9.5.5.15, the loss allowance for trade receivables is always
measured at an amount equal to the lifetime expected credit losses. A provision
matrix can be used to determine the amount of lifetime expected credit losses on
trade receivables.

CALCULATIONS

C1. Loss allowance on trade receivables

Provision matrix

Gross Default rate Lifetime

carrying expected credit
amount loss allowance
R R
Current 4 072 500 0,3% 12 218 [½]
1-30 days past due 543 000 1,1% 5 973 [½]
31-60 days past due 362 000 3,1% 11 222 [½]
61-90 days past due 271 500 6% 16 290 [½]
More than 90 days past due 181 000 13% 23 530 [½]
Total 5 430 000 69 233 [2½]

Transaction 10 Dr Cr
R R
28 February 20.23
J1 Financial liability at amortised cost (SFP) [C2] 78 344 (3½)
Loss from derecognition of loan payable (P/L) (balancing) 1 656 (1)
Ordinary share capital (SCE) (10 000 x R8,00)
Derecognition of loan payable 80 000 (1)
(5½)

C2. Settlement with equity instruments

Effective interest rate

N = 4 years [½]
PV = (98 500) [½]
PMT = 33 475 [½]
FV = 0 [½]
I = 13,522%

35
 Amortisation table of loan

Opening Effective Interest Closing

balance Interest balance
Date fixed at
13,522%
R R R R

31 December 20.23 98 500 13,319 (33 475) 78,344 [1]

[3]

DISCUSSION

The issue of an entity’s equity instruments to a credit to extinguish all or part of a

financial liability is seen as consideration paid. Fincor Ltd will remove the loan
payable from its statement of financial position, since the shares were issued as full
and final settlement of the loan payable (IFRIC 19).

(c) Deferred tax

Temporary Deferred
Carrying Tax differences tax
Notes
amount base at 100% or asset/
80% (liability)
R R R R

Investment in Bamboo 581 250 301 200 1 280 050 (75 614) (2)
(transaction 1)
(25 000 x 23,25);
(25 000 x 12,00) + 1 200
Investment in Brick 202 500 181 800 2 (16 560) (4 471) (2)
(at 80%) (transaction 2)
(15 000 x 13,50);
(15 000 x 12) + 1 800
Investment in Dodgeball - - - - (1)
(transaction 3)
(5)

DISCUSSION

1. Tax base of an asset: Amounts deductible in the future. Take note that 100% of the
temporary differences are included in the deferred tax calculation, since the
investment is of a speculative nature.

2. Tax base of an asset: Amounts deductible in the future. If the investment is disposed
of in the future it will result in capital gains tax. The amount that will be deductible
from the proceeds is the tax base of the investment (cost of the investment plus
transaction costs). Take note that the capital gains tax inclusion rate of 80% is
applied to the deferred tax calculation, as the investment is of a capital nature since
it is held for long-term purposes.

36
 TOPIC 1.6 - THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES
INTRODUCTION

The key issues in accounting for the effects of changes in foreign exchange rates are to
determine the appropriate exchange rate to be used for the initial and subsequent
recognition of foreign currency transactions in the functional currency of the reporting entity,
and how to recognise exchange differences that arise on these transactions.

In this learning unit we will focus on foreign currency transactions only. The translation of
foreign operations will be dealt with in Learning unit 5.

PRESCRIBED STUDY MATERIAL

IAS 21 The Effects of Changes in Foreign Exchange Rates

SAICA Student Handbook 2022/2023; Volume1; Part A1; pages A1488 to A1507

IAS 21 was covered as part of your undergraduate studies. It is important that you revise
the study material and concepts if you are not familiar with the content.

Also note that Unisa follows the limited open-book policy as prescribed by SAICA and that
you will be allowed to use the SAICA Student Handbook during assessments.

Let’s look at the overview of IAS 21 The Effects of Changes in Foreign Exchange Rates.

37
Overview of IAS 21 The Effects of Changes in Foreign Exchange Rates

Foreign exchange activities

Foreign currency transactions Translation of financial statements and

foreign operations
(Learning unit 5)

Hedging of foreign Hedge of a net investment in a

currency transactions foreign operation
(Learning unit 5)

The following concepts and topics in IAS 21 are excluded from the syllabus:
• Hyperinflation
• Changes in functional currency

38
EXAMPLE

Complete the following question.

QUESTION 1 (20 marks/ 30 minutes)

On 1 September 20.21 Ebenezer Ltd placed a cancellable order amounting to $120 000 to purchase
inventory from a supplier in the USA. The inventory was shipped free on board, at the agreed port of
departure. The inventory was delivered to the Port Newark-Elizabeth Marine Terminal, New Jersey,
which is the agreed port of departure, on 28 September 20.21. The inventory was loaded on the ship on
28 September 20.21, but the ship only departed to South Africa on 10 October 20.21. Ebenezer
obtained control of the inventory on 28 September 20.21.

The debt was payable as follows:

$

1 December 20.21 72 000

15 January 20.22 48 000
120 000

By 31 December 20.21 30% of the inventory was sold on credit, while the other 70% was sold during
the year ended 31 December 20.22 for cash. Ebenezer Ltd had no closing inventory on 31 December
20.20 and 31 December 20.22.

The applicable exchange rates were as follows:

$1 = R

1 September 20.21 7,70

28 September 20.21 7,78
10 October 20.21 7,74
15 November 20.21 7,71
1 December 20.21 7,80
31 December 20.21 7,72
15 January 20.22 7,85

Additional information

1. Profit before tax, before taking the acquisition of the inventory into account, for the years ended
31 December 20.21 and 31 December 20.22, amounted to R1 250 000 and R1 900 000,
respectively. The revenue on the sale of the inventory has been correctly recorded.

2. It is the company’s policy not to hedge its foreign currency exposure on foreign currency
transactions due to the fact that these transactions take place on an ad hoc basis. As a result,
Ebenezer Ltd did not take out a forward exchange contract (FEC) to hedge its foreign currency
risk on the future payment of the foreign creditor.

3. Assume the time value of money relating to the foreign creditor is not material.

39
REQUIRED
Marks
(a) Prepare the journal entries in respect of the above transaction for the years ended 31 17
December 20.21 and 31 December 20.22.

(b) Prepare the profit before tax note to the financial statements for the year ended 3
31 December 20.22 in respect of the above transaction.

Please note:

• Round off all amounts to the nearest rand.

• Ignore any normal income tax implications.
• Ignore any Value Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

40
QUESTION 1 - Suggested solution

DISCUSSION

Drawing a quick timeline can be of great assistance. An example of the timeline for this
question is as follows:

REMEMBER

Foreign currency transactions:

- Record inventory (non-monetary item) and foreign creditor (monetary item) at spot
rate on transaction date (IAS 21.21).
- Restate creditor (monetary item) to closing rate at year end or spot rate on settlement
date and recognise the foreign exchange differences in P/L (IAS 21.23).

(a) JOURNAL ENTRIES

Dr Cr
R R
Year ended 31 December 20.21
28 September 20.21
J1 Inventory (SFP) ($120 000 x 7,78) 933 600 (1½)
Creditor (SFP) 933 600 (½)
Record inventory purchased on transaction date
1 December 20.21
J2 Foreign exchange difference (P/L)
(refer to P/L1 on timeline) ($120 000 x (7,80- 7,78)) 2 400 (2)
Creditor (SFP) 2 400 (½)
Remeasure entire creditor to spot rate on date of first
payment (loss)
J3 Creditor (SFP) ($72 000 x 7,80) 561 600 (1½)
Bank (SFP) 561 600 (½)
Make first payment to creditor at spot rate
31 December 20.21
J4 Creditor (SFP) (refer to P/L2 on timeline)
($48 000 x (7,80 – 7,72)) 3 840 (2)
Foreign exchange difference (P/L) 3 840 (½)
Remeasure creditor to closing rate at year end (gain)
J5 Cost of sales (P/L) (R933 600 (refer J1) x 30%) 280 080 (1½)
Inventory (SFP) 280 080 (½)
Transfer cost of inventory sold to P/L (cost of sales)

41
 Dr Cr
R R
Year ended 31 December 20.22
15 January 20.22
J6 Foreign exchange difference (P/L)
(refer to P/L3 on timeline) ($48 000 x (7,85 – 7,72)) 6 240 (2)
Creditor (SFP) 6 240 (½)
Remeasure creditor to spot rate on date of settlement
(loss)
J7 Creditor (SFP) ($48 000 x 7,85) 376 800 (1½)
Bank (SFP) 376 800 (½)
Final payment to settle creditor at spot rate
31 December 20.22
J8 Cost of sales (P/L) (R933 600 x 70%) 653 520 (1)
Inventory (SFP) 653 520 (½)
Transfer cost of inventory sold to P/L (cost of sales)
Total (17)

(b) EBENEZER LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.22

2. Profit before tax 20.22 20.21

R R
The following items are included in profit before tax:

Income
Net foreign exchange gains (J2 and J4 in part (a)) - 1 440 (1½)
Expenses
Net foreign exchange losses (J6 in part (a)) 6 240 - (1½)
Total (3)

EXAM TECHNIQUE

Always provide the comparative information in a disclosure question, except if required not
to do so.

The treatment of foreign exchange differences corresponds with the treatment of the gain
or loss of the underlying non-monetary item. Therefore, the net foreign exchange
differences will be recognised in profit or loss and the net amount disclosed in the financial
statements.

42
INTEGRATED QUESTIONS

Question Question name Marks Topics covered

1 Jota Ltd 25 Disclosure: Income taxes

Discussion: Prior year error
2 Lallana Ltd 27 Disclosure: Income taxes
Maiweather Ltd Discussion: Presentation of financial statements
3 Leo Ltd 35 Financial instruments
Presentation of financial statements
Income taxes
4 Satoshi Ltd 40 Financial instruments
The effects of foreign exchange rates Other
(Share-based payment)
5 Shantui 20 Financial instruments
Construction Ltd The effects of foreign exchange rates
6 Exclusive Clocks Ltd 15 Financial instruments
7 Ultra Motors Ltd 25 Financial instruments
The effects of foreign exchange rates
Case study
1 Mining Ltd 100 The Conceptual Framework for Financial
Reporting
Income taxes
Financial instruments
Presentation of financial statements
Other (Leases, etc.)

43
QUESTION 1 25 marks

YOU HAVE 9 MINUTES TO READ THIS QUESTION

ALL AMOUNTS EXCLUDE VALUE ADDED TAX (VAT) UNLESS OTHERWISE INDICATED.

You are a student studying towards your Certificate in the Theory of Accountancy (CTA) qualification.
As part of your preparation for your final financial accounting examination, you assisted an audit firm
with the following client queries:

Jota Ltd (Jota)

Jota conducts business in the retail industry. You are responsible for the preparation of the financial
statements of Jota for the year ended 31 December 20.20.

The following information is available for the 20.20 financial year.

DRAFT SUMMARISED TRIAL BALANCE AS AT 31 DECEMBER 20.20

Dr Cr
Notes
R R
Office buildings at carrying amount 1 2 442 000
Plant and machinery at carrying amount 1 945 000
Inventory 831 500
Cash and cash equivalents 2 044 000
Prepaid insurance premium 2 88 900
Trade and other receivables 3 2 405 600
Deferred tax asset (1 January 20.20) Deferred tax liability Cr 4 122 360
Share capital (R29 400) 350 000
Retained income Amend retained 5 956 860
Profit before tax earnings as the 5 882 500
Trade payables balancing amount 1 690 000
8 879 360 8 879 360

Notes

1. Property, plant and machinery

Property, plant and machinery are accounted for according to the cost model in terms of IAS 16
Property, Plant and Equipment.

On 1 January 20.20 Jota purchased land for the future development of a new plant. Due to the
worldwide economic crisis and a decline in the property market during the second half of 20.20,
the directors agreed to sell the land as soon as possible. The land was sold on 31 October 20.20
at a loss of R200 000 (which is a capital loss for tax purposes – also refer note 4). The purchase
and sale transactions on land were correctly recorded in the accounting records of Jota.

Jota depreciates the office buildings at R165 500 per annum, while the South Africa Revenue
Service (SARS) permits no deduction on the buildings.

The tax base of the plant and machinery on 31 December 20.20 was R546 000.

44
2. Insurance contract

The annual insurance premium of R88 900 for the year ending 31 December 20.21 was paid in
advance during the current financial year. There were no prepaid expenses for the financial year
ending 31 December 20.19.

3. Trade and other receivables

Trade and other receivables consisted of the following on 31 December 20.20:

Dr/(Cr)
R
Trade receivables 2 595 300
Allowance account for credit losses (410 600)
Other receivables 220 900
Balance at year end 2 405 600

SARS allowed Jota to claim a doubtful debt allowance of R102 650 in terms of section 11(j) of the
Income Tax Act.

4. Deferred tax asset Deferred tax liability

The net deferred tax liability of R29 400 at 31 December 20.19 was correctly calculated and
consists of the following:

Dr/(Cr)
R
Property, plant and equipment (143 661)
Allowance account for credit losses 67 221
Unused tax loss 47 040
Net deferred tax liability (29 400)

All the temporary differences that gave rise to the net deferred tax liability of R29 400 were taxed
at 27%. The final tax assessment issued by SARS for the financial year ended
31 December 20.19 reflected an assessed tax loss of R174 222 which was accepted by Jota.

On 31 December 20.19 the management of Jota was of the opinion that future taxable profits and
future capital gains were probable as the budget for the coming financial year showed a sharp
increase in profits as a result of a new contract obtained by Jota. This opinion of management
remained unchanged for the financial year ended 31 December 20.20.

The current tax expense for the year ended 31 December 20.20 was correctly calculated at
R657 434 (after taking into account all the information provided in these notes). Deferred tax for
the year ended 31 December 20.20 has not yet been calculated or provided for.

5. Profit before tax

You may assume that all transactions, except for the accounting error in note 6, were correctly
accounted for in profit before tax.

The following items are included in profit before tax:

5.1 Dividend income received from a local resident company to the amount of R140 000.

45
 5.2 Fines

On 28 July 20.20 the Competition Commission fined Jota for retail price fixing. The
Competition Commission imposed a penalty of R1 398 500 on Jota because of the existence
of a vertical agreement between Jota and Origi Ltd for setting retail prices. The fine was
immediately payable.

6. Accounting error

On 30 November 20.19 Jota received an amount of R575 000 (VAT inclusive) from a customer
for services that were only rendered during March 20.20. The accountant recognised the
R575 000 as revenue in November 20.19 and did not allocate the VAT of 15% to the VAT output
account. As a result the R575 000 was included in revenue for the financial year ended
31 December 20.19. For tax purposes, the R575 000 was taxed in the financial year ended
31 December 20.19. SARS indicated that they will re-open the 20.19 assessment to correct the
amount of VAT that was incorrectly included in taxable profit. The figures in the trial balance have
not yet been adjusted to account for the correction of the accounting error (the error is regarded
as material).

Additional information

• The normal tax rate is 27%. The capital gains tax inclusion rate is 80% for the years ended
31 December 20.19 and 31 December 20.20.

• The VAT rate is 15% for all periods.

• Jota is a registered VAT vendor.

46
REQUIRED

YOU HAVE 38 MINUTES TO ANSWER THIS QUESTION

Marks
(a) Prepare the following note to the financial statements of Jota Ltd for the financial year 16
ended 31 December 20.20:

• Income tax expense in terms of IAS 12.79-12.80 and 12.81(c)(i).

Please note:
• Comparative figures are not required.
• The movement in temporary differences in the current tax calculation must be
calculated using the statement of financial position method.

(b) Discuss the effect that the correction of the R575 000 with regard to services rendered 8
(which was incorrectly recognised as revenue in the 31 December 20.19 financial year)
will have on all the line items in the statement of profit or loss and other
comprehensive income of Jota Ltd for the year ending
31 December 20.20.

Communication skills: logical argument 1

Please note:
• Your discussion should include amounts where relevant.

Please note:
• Round off all calculated amounts to the nearest Rand.
• Your answer must comply with International Financial Reporting Standards (IFRS).

47
QUESTION 1 – Suggested solution

(a) JOTA LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.20

3. Income tax expense

Major components of tax expense

20.20
R
SA normal tax
Current tax
Current year (given) 657 434 (1)
Deferred tax 110 986
Movement in temporary differences (taxable) [C1] 107 146 (7)
Unused tax loss utilised [C1] 47 040 (1)
Unused capital loss created [C1] (43 200) (1)
768 420
Tax rate reconciliation
Accounting profit (882 500 + (575 000 x 100/115))) 1 382 500 (1)
Tax at 27% 373 275 (1)
Tax effect of non-taxable /non-deductible items
Dividends not taxable (140 000 x 27%) (37 800) (1)
Capital loss on sale of land not deductible
(200 000 x 20% x 27%) 10 800 (1)
Depreciation on office buildings not deductible
(165 500 x 27%) 44 550 (1)
Penalties not deductible (1 398 500 x 27%) 377 595 (1)
768 420
Total (16)

48
CALCULATIONS

C1. Deferred tax

Deferred
The office building has no tax Temporary
allowance, and the tax base is thus tax at
Carrying Tax difference
nil. Therefore, the temporary 27%
amount base at 100% or
difference for PPE in 20.19 relates asset/
80%
to the plant and machinery. (liability) (½)
R R R R
31 December 20.19
Property plant and equipment
(given) ? ? 1532 078 (143 661) (1)
Allowance for credit losses
(given) ? ? 2(248 967) 67 221 (1)
Revenue received in advance
(error) 500 000) - (500 000) 135 000 (1)
(216 889) 58 560
Unused tax loss (given) 174 222 (174 222) 47 040 (1)
Net deferred tax asset (391 111) 105 600
1 143 661/27% = 532 078
2 67 221/27% = 248 967
3 575 000 x 100/115 = 500 000

31 December 20.20
Office building 2 442 000 - Exempt - (1)
Property plant and equipment 945 000 546 000 399 000 (107 730) (1)
Allowance for credit losses
(given) (410 600) 1(102 650)
(307 950) 83 147 (1½)
Prepaid insurance premium 88 900 - 88 900 (24 003 (1)
179 950 (48 586)
Unused capital loss - 200 000 2(160 000) 43 200 (1)
19 950 (5 386)
1 410 600 x 25% = 102 650 or 410 600 – (410 600 x 75%) = 102 650
2 200 000 x 80% = 160 000

Movement in temporary differences (excluding unused)

tax loss and unused capital loss) (taxable)
(179 950 - (216 889)) 396 839 (107 146)
Movement in unused tax loss (reversal of deductible) 174 222 (47 040)
Movement in unused capital loss (deductible) (160 000) 43 200
Total movement in temporary differences 411 061 (110 986)

49
(b) Discuss the correct accounting treatment of the accounting error

The R575 000 which have been incorrectly recognised as revenue in the
31 December 20.19 financial year constitute a prior period material error in terms of
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors and has to be
corrected retrospectively. (1)
An entity shall correct material prior period errors retrospectively in the first set of
financial statements authorised for issue after their discovery by restating the
comparative amounts for the prior period(s) presented in which the error occurred
(IAS 8.42 (a)). (1)
A prior period error shall be corrected by retrospective restatement as the period-specific
effect is not impracticable to determine (the applicable financial year is 20.19)
(IAS 8.43). (1)
Jota must, therefore, correct the error in the financial statements for the year ended
31 December 20.20 by restating the 20.19 comparative figures. (1)
The following line items of the statement of profit or loss and other comprehensive
income have been affected by the error and must be restated as follows:
• The 20.19 comparative figures for revenue must be decreased with R575 000
since it should be reflected as revenue received in advance for the year ended
31 December 20.19. Revenue amounting to R500 000 (excluding VAT) must only be
recognised in March 20.20. Therefore, the revenue for the year ended
31 December 20.20 need to be increased with R500 000. (2)

• The 20.19 comparative figures for the income tax expense (current tax) has to
be decreased with R20 250 (R75 000 x 27%), to correct the VAT that was incorrectly
included in the 20.19 comparative figures for revenue, since the SARS agreed to
reopen the prior year assessment. (2)

• The 20.19 comparative figures for income tax expense (deferred tax) has to be
decreased with R135 000 (500 000 x 27%), to provide for the deferred tax asset
relating to the revenue received in advance. (1)
Total (9)
Maximum (8)
Communication skills: logical argument (1)

50
QUESTION 2 27 marks

YOU HAVE 10 MINUTES TO READ THIS QUESTION

IGNORE ANY VAT IMPLICATIONS

You are an IFRS expert who is employed by Jsauhm Consultants. The following independent and
unrelated issues were brought to your attention for your expert advice and opinion.

Client 1: Lallana Ltd (Lallana) 18 marks

Lallana is a company operating in the manufacturing and maintenance industry. Lallana is listed on the
Johannesburg Stock Exchange and has a 31 December financial year end.

You are currently reviewing the financial statements of Lallana. Your assistant has presented the
following schedule of information relating to the year ended 31 December 20.27:

Item R
Lallana's accounting profit for the year ended 31 December 20.27 after correctly
accounted for all items: 5 750 000
Dividends received:
Dividends received are exempt from normal tax in terms of s 10(1)(k). 74 500
Foreign income received (after deduction of R5 000 relating to foreign taxes): 35 000
The foreign income is not taxable in South Africa.
Gain on disposal of land: 350 000
Lallana purchased land for the future development of a new factory building on
31 March 20.26. Due to the recent availability of factory buildings in the area, Lallana sold
the land at an amount of R1 550 000 on 1 January 20.27. The original cost of the land
amounted to R1 200 000. Land is measured according to the cost model in terms of
IAS 16 Property, Plant and Equipment. The proceeds from the sale of land is a receipt of
a capital nature for tax purposes.
Depreciation on plant and equipment: 876 000
The tax allowances on the plant and equipment amounted to R900 000. On
31 December 20.27 the carrying amount of the plant and equipment amounted to
R3 168 000 while the tax base was R2 500 000.
Correction of prior period error: 300 000
On 30 November 20.26 Lallana received an amount of R300 000 from a customer for
services that were rendered during February 20.27. The accountant recognised the
R300 000 as revenue in November 20.26. For tax purposes, the R300 000 was taxed in
the financial year ended 31 December 20.26.
Assessed tax loss on 31 December 20.27: -
Lallana suffered operating losses during the previous financial year and had an assessed
tax loss of R900 000 on 31 December 20.26. The company correctly utilised R344 000 of
the assessed tax loss by recognising a deferred tax asset of R96 320 relating to the
assessed loss on 31 December 20.27.

51
Additional information

1. There are no temporary differences other than those that are apparent from the information
contained in the question.

2. The only non-taxable and non-deductible items included in the accounting profit or loss are those
that are apparent from the information provided.

3. The normal income tax rate is 27% and the capital gains tax inclusion rate is 80%.

4. You may assume that all amounts are material.

Client 2: Maiweather Ltd (Maiweather) 9 marks

The financial manager, Mr Matlala, prepared the statement of financial position of Maiweather as at
31 December 20.27 and sent you a copy for a final review. You have assisted Mr Matlala with the
previous year's financial statements and he awaits your feedback to finalise the financial statements for
the year ended 31 December 20.27 before he sends it to the chief financial officer for approval.
Mr Matlala provided you with notes regarding the matters that he is unsure of.

MAIWEATHER LTD

STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.27

Notes 20.27
R’000
ASSETS
Non-current assets
Property, plant and equipment 39 500
Intangible assets 6 700
46 200
Current assets
Inventories 20 200
Trade receivables 1 20 500
Other current assets 1 500
Cash and cash equivalents 2 500
44 700
Total assets 90 900

52
 Notes 20.27
R’000
EQUITY AND LIABILITIES
Equity attributable to the owners of the parents
Share capital 14 200
Retained earnings 31 000
Other components of equity 1 500
Total equity 46 700

Non-current liabilities
Long-term borrowings 2 24 600
Total non-current liabilities 24 600

Current liabilities
Trade and other liabilities 3 300
Allowance for credit losses 1 1 500
Short-term borrowings 3 2 500
Current tax payable 9 500
Deferred tax 2 800
Total current liabilities 19 600
Total liabilities 44 200
Total equity and liabilities 90 900

Notes

1. Maiweather uses the simplified approach in accordance with IFRS 9 Financial Instruments when
determining the expected credit losses for trade receivables. The R1 500 000 allowance for credit
losses is the lifetime expected credit losses of the trade receivables.

2. Long-term borrowings of R24 600 000 represents a loan obtained from Africa Bank. The interest
rate charged by Africa Bank is market related. The loan is repayable over 10 years. The loan
instalments of R4 500 000 each are payable on 31 December of each year. The instalment on 31
December 20.28 will consist of R1 860 000 interest and a R2 640 000 capital re-payment.

3. On 1 April 20.27 Maiweather obtained a short-term loan from Smart Bank amounting to
R2 500 000. The loan and interest is repayable on 31 March 20.28, however the terms of the
agreement stipulates that Maiweather has the discretion to extend the loan's repayment date to
31 December 20.29 at an additional fee of R50 000. The applicable interest rate for the extended
period will be renegotiated. Mr Matlala indicated that the chief financial officer has instructed him
to start with the negotiation of the new interest rate for the extended loan period with Smart Bank
since Maiweather intends to extend the loan.

53
REQUIRED

YOU HAVE 41 MINUTES TO ANSWER THIS QUESTION

Marks
(a) Prepare the income tax note to the financial statements of Lallana Ltd for the year 17
ended 31 December 20.27 as required by IAS 12.79, 80 and 81(c)(i) Income Taxes
(refer to client 1).

Please note:
• Comparative figures are not required.
• The movement in temporary differences in the current tax calculation has to be
calculated by using the statement of financial position method.

Communication skills: presentation and layout 1

(b) Discuss the presentation and classification issues in terms of IAS 1 Presentation of 8
Financial Statements relating to the statement of financial position of Maiweather Ltd
as at 31 December 20.27 (refer to client 3).

Please note:
• Your feedback should include any incorrect presentation and classification and
the suggested corrections of the errors noted.
• Your answer should include calculations.

Communication skills: logical argument 1

Please note:
• Round off all amounts to the nearest Rand.
• Your answer must comply with International Financial Reporting Standards (IFRS).

54
QUESTION 2 – Suggested solution

(a) LALLANA LTD

NOTES FOR THE YEAR ENDED 31 DECEMBER 20.27

11. Income tax expense

Major components of tax expenses

20.27
R
SA normal taxation
Current tax
- Current year 1 172 205 (5)
Deferred tax 180 360
- Movement in temporary differences 87 480 (4)
- Recognition of unused tax loss not previously recognised
((900 000 – 344 000) x 27%)) (150 120) (1)
- Unused tax loss uitilised (900 000 x 27%) 243 000 (1)
1 352 562
Foreign Tax 5 000 (1)
1 357 565
Tax rate reconciliation
Accounting profit 5 750 000 (½)
Taxation at 27% 1 552 500 (½)
Tax effect of non-deductible/non-taxable items:
- Dividends received (74 500 x 27%) (20 115) (1)
- Accounting profit on land not taxable (350 000 x 20% x 27%) (18 600) (1)
Difference in tax rate on foreign income (5 000 - (40 000 x 27%) (5 800) (1)
Unused tax loss that was not previously recognised (150 120) (1)
1 357 565
Total (17)
Communication skills: presentation and layout (1)

55
CALCULATIONS

C1. Deferred tax

Deferred
Temporary
tax
Carrying Tax difference
27%
amount base at 100% or
asset/
80%
(liability)

31 December 20.26
Land 1 200 000 1 200 000 - -
Plant (3168 + 876) (2500 + 900) 4 044 000 3 400 000 644 000 (173 880)
Contract liability (300 000) - (300 000) 81 000
344 000 (92 880)
Unused tax loss 900 000 (344 000) 92 880
- -
31 December 20.27
Land - - - -
Plant 3 168 000 2 500 000 668 000 (180 360) [1]
668 000 (180 360)
Unused tax loss - - - -
668 000 (180 360)
Movement in temporary differences
through P/L (668 000 - 344 000) 324 000 (87 480) [3]
Movement in unused tax loss 344 000 (92 880)
668 000 (180 360)

C2. Current tax calculation

Profit 5 750 000

Non-taxable/Non-deductible items:
- Dividends received not taxable (74 500) [½]
- Accounting profit on land not taxable (350 000 x 20%) (70 000) [1]
- Foreign income (35 000 + 5 000) (40 000) [1]
Movement in temporary differences (324 000) [1]
Taxable profit before tax loss 5 241 500
Unused loss of prior year (900 000) [1]
4 341 500
Tax at 27% 1 172 205 [½]
[5]

56
(b) Maiweather Ltd

Comparative information
According to IAS 1.38 an entity shall present comparative information in respect of the
preceding period for all amounts reported in the current period's financial statements.

IAS 1.38A stipulates that a minimum of two statements of financial position shall be
presented.

Maiweather Ltd needs to present comparative information in respect of the preceding

financial period ended 31 December 2016, this will also ensure there is a minimum of
two statements of financial position presented. (2)

Long-term borrowings
IAS 1.61 stipulates that an entity shall disclose the amount expected to be settled after
more than twelve months for each liability line item that combines amounts expected to
be settled no more than twelve months after reporting period and more than twelve
months after reporting period.

Therefore, the amount that is included in the R24 600 000 long-term borrowings that will
be settled on or before 31 December 20.28 must be shown as the current portion of
long-term borrowing and classified as current liabilities. (1)

The capital re-payment amount of R2 640 000 must be disclosed as current liabilities
and the amount of R21 960 000 (R24 600 000 – R2 640 000) as non-current liabilities. (1)

Offsetting
In terms of IAS 1.32 and .33 an entity shall not offset assets and liabilities and should
report both assets and liabilities separately.

According to IAS 1.33 measuring assets net of valuation allowance is not offsetting.

Therefore, the classification of the allowance for credit losses under current liabilities is
not correct and should be offset against the trade receivables of R20 500 000. (1)

The final trade receivables presented in the statement of financial position should be
R19 000 000 (R20 500 000 – R1 500 000). (1)

Short-term borrowings
In terms of IAS 1.73 if an entity expects and has the discretion to roll over an obligation
for at least 12 months after the reporting period under an existing loan facility, it classifies
the obligation as non-current even if it would otherwise be due within a shorter period.

According to the terms of the loan agreement Manyonga Ltd has the discretion to roll
over the loan from Smart Bank and Manyonga Ltd expects that the entity will roll over
the loan since they have already started to negotiate this with Smart Bank. (1)

The loan of R2 500 000 should be classified as non-current liabilities since the rollover
of the loan to 31 December 20.29 is more than 12 months after the reporting period of
31 December 20.27. (1)

Deferred tax
According to IAS 1.56 when an entity presents current and non-current liabilities as
separate classifications in its statement of financial position, deferred tax liabilities shall
not be classified as current liabilities.

Therefore, the deferred tax balance of R2 800 000 is incorrectly classified as current
liabilities and should be classified as part of non-current liabilities. (1)
Total (9)
Maximum (8)
Communication skills: logical argument (1)

57
QUESTION 3 35 marks

YOU HAVE 13 MINUTES TO READ THIS QUESTION

Leo Ltd (Leo) specialises in the manufacturing and selling of sports clothing products and is listed on
the Johannesburg Stock Exchange. Leo Ltd is a wholly owned subsidiary of Panther Ltd (Panther) since
its incorporation. You are a recently qualified chartered accountant and recently started working at Leo
Ltd as a financial accountant. You are preparing the financial statements for the financial year end
31 December 20.20 and have been provided with the following information:

1. Preference shares

Leo issued 800 000 compulsory convertible preference shares at an issue price of R10 per
preference share on 1 July 20.20. The convertible preference share has a face value of R11 each.
Dividends are payable annually on 30 June at 12%. These preference shares are compulsory
convertible on 30 June 20.25 at one ordinary share for each preference share held. A market-
related interest rate on 1 July 20.20 for preference shares issued without conversion rights was
10% per annum.

Panther purchased the 800 000 preference shares when they were issued and does not hold them
for trading purposes. The fair value of one convertible preference shares was R12 on
31 December 20.20.

2. Share-appreciation rights

On 1 January 20.19 Leo entered into an agreement with the directors of Panther. According to the
agreement all 12 directors of Panther will each receive 4 500 share appreciation rights (SARs).
This is part of Panther’s remuneration policy for subsidiaries to reward its executive directors. The
SARs will vest on 31 December 20.21, provided that the directors remain in service of Panther.

Each SAR entitles the director to a cash amount equal to Leo’s share price on the exercise date.
Vested SARs may be exercised on or before the earlier of 31 December 20.23 or the date on
which an employee resigns. If they are not exercised by this date, the rights will lapse.

The fair value of SARs was determined using an option pricing model. The following information
in respect of the SARs scheme is provided:

Estimated
Actual number
number of
of employees
employees Fair value per Leo
Date still employed
expected to be SAR share price
at relevant
employed at
date
vesting dates
R R
1 January 20.19 12 11 7,80 35
31 December 20.19 12 11 8,20 38
31 December 20.20 11 10 9,50 39
31 December 20.21 ? 10 10,20 41

58
3. Bond at fair value

Leo purchased a foreign bond on 1 January 20.20 for its fair value (which also equalled the face
value at this date). Leo correctly classified this bond at fair value through other comprehensive
income. The bond has five years to maturity and carries an arrear annual coupon rate of 8%
payable on 31 December each year. The bond coupon rate is equivalent to its effective interest
rate, as there are no transaction costs nor premium or discount on redemption of the bond relative
to the face value.

The credit risk since initial recognition of the bond is determined as follows:
• 1 January 20.20 – low credit risk, and
• 31 December 20.20 – no change since initial recognition

Details relating to the bond:

Bond
Date
Total expected credit losses
Spot rate Fair value 12 Month Lifetime
$1= $ $ $
1 January 20.20 R12,50 120 000 1 800 2 500
31 December 20.20 R13,75 128 000 1 800 2 750
Average rate 20.20 R11,12

At no stage was the bond considered to be credit impaired and the interest payments were
received on time.

Assume that the South African Revenue Services (SARS) will not allow expected credit losses on
the bonds as a deduction for income tax purposes and that the SARS accepts the amortised cost
of the bonds as the tax base of the bonds. Only when the credit risk realises will the SARS allow
such losses as actually incurred.

The SARS indicated that any future taxable profits will be taxed at 27%.

59
QUESTION 3

YOU HAVE 53 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks
(a) Discuss how Panther Ltd should classify the compulsory convertible preference 7
shares.

Communication skills: clarity of expression 1

(b) Prepare an extract of the statement of financial position of Leo Ltd as at

31 December 20.20, showing how the convertible preference shares and share 9
appreciation rights will be presented.

Please note:
• Comparatives are not required.
• Ignore all tax implications.

Communication skills: presentation and layout 1

(c) Provide the journal entries to account for the bond for the year ended 13
31 December 20.20 in the accounting records of Leo Ltd.

Please note:
• Journal narrations are not required.
• Journals should be dated.
• Ignore all tax implications.

(d) Discuss the tax implications of the bond transaction. Calculations are not required. 4

Please note:
• Round off all amounts to the nearest rand.
• Your answer must comply with International Financial Reporting Standards (IFRS).

60
QUESTION 3 – Suggested solution

(a) Preference shares

Panther purchased the convertible preference shares and should recognise a financial
asset and determine classification in terms of IFRS 9. (1)

To classify the preference shares, consideration of the nature of the contractual cash
flows should be made: (1)

• Panther has a contractual right to receive dividends annually in the form of interest (1)
income.
• There is no capital repayment, since the preference shares are compulsory (1)
convertible into shares. Panther has the right to receive ordinary shares.
• The contractual cash flows do not represent payments solely of interest and (1)
capital. Therefore, the amortised cost classification to measure debt instruments
cannot be applied. (1)

Panther should then consider classification at fair value through profit or loss or the
option to elect fair value thorough other comprehensive income in terms of IFRS 9.5.7.5. (1)

However, the IFRS 9.5.7.5. cannot be elected by Panther, since the preference shares
are not pure equity instruments, as there is a contractual right for Panther to receive
interest payment. (1)

Therefore, Panther should classify the preference shares as measured at fair value
through profit or loss (1)
Total (9)
Maximum (7)
Communication skills: clarity of expression (1)

(b) LEO LTD

EXTRACT OF STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20.20

R
Equity and liabilities
Equity component of convertible preference shares (C1) 3 996 929 (3)

Non-current liabilities
Financial liability (4 203 225 (C1.2) – 200 153) 4 003 072 (3)
Cash settled share-based payment (4 500 x 10 x 9,50) 130 000 (2)

Current liabilities
Financial liability – short term portion (C1.2) 200 153 (1)
Total (9)
Communication skills: clarity of expression (1)

61
CALCULATIONS

C1. Convertible preference shares

C1.1 Fair value of financial liability component

N = 5 [½]
I = 10% [½]
PMT = 1 056 000 (800 000 x R11 x 12%) [½]
FV = 0 [½]
PV = 4 003 071

Proceeds (800 000 x R10) 8 000 000 [1]

Present value of financial liability (4 003 071)
Equity component (balancing) 3 996 929
[3]

C1.2 Value of liability component

4 003 071 [C1.1] + 1 Amort interest 400 307 x 6/12 = 200 153 4 203 225 [2]

(c) Journal entries – Bonds

Dr Cr
R R
1 January 20.20
J1 Financial asset at fair value through OCI: bond 1 500 000 (1)
(SFP)
(120 000 x 12,5) 1 500 000 (1)
Bank (SFP)
Recognise purchase of bond
J2 Expected credit losses (P/L) (1 800 x 12,5) 22 500 (1)
Expected credit loss reserve (OCI)
Recording 12-month expected credit loss 22 500 (1)

J3 31 December 20.20
Bank (SFP) (120 000 x 8% x 13,75) 132 000 (1)
Financial asset at fair value through OCI: bond 25 248 (1)
(balancing) (SFP)
Interest income (P/L) (120 000 x 8% x 11,12) 106 752 (1)
Recognise effective interest income and coupon
interest received
J4 Financial asset at fair value through OCI: bond (SFP) 175 248 (1)
((1 500 000 (J1) - 25 248 (J3)) – (120 000 x13,75))
Expected credit loss reserve (OCI 2 250 (1)
((22 500 (J2) - 1 800 x 13,75)
Foreign exchange gain (OCI) (175 248 – 2 250) 172 998 (1)
Recognition of foreign exchange gain
J5 Financial asset at fair value through OCI: bond (SFP) 110 180 (2)
Fair value gain (OCI) 110 180 (1)
((1 500 000 (J1) – 25 248 (J3) + 175 248 (J4)) –
(128 000 x13,75))
Recognition of fair value gain on investment
Total (13)

62
(d) Discuss deferred tax implications on bond

There is no deferred tax on the amortised cost accounting for the bond, as the carrying
amount and tax base will be the same. (1)

Expected credit losses on the bond are not allowed as a deduction for income tax
purposes, and only when the credit risk realises will the SARS allow such losses as (1)
actually incurred.
The interest income and foreign exchange adjustments will attract current tax at the
normal tax rate of 27%. (1)

The Income Tax Act does not allow a tax deduction for fair value adjustments and,
therefore, there will be deferred tax consequences on the fair value adjustments
recognised in other comprehensive income. (1)

As the bond is held to collect contractual cash flows and for sale (requirement to account
for at fair value through OCI), it is likely that the applicable tax rate on sale of the bond is
the normal tax rate of 27%. Therefore, the CGT rate will not be applicable. (1)
Total (5)
Maximum (4)

63
QUESTION 4

YOU HAVE 15 MINUTES TO READ THIS QUESTION

PART I 28 marks

IGNORE ANY NORMAL INCOME TAX IMPLICATIONS

Satoshi Ltd (Satoshi) is a South African company listed on the Johannesburg Stock Exchange and has
a 31 December year end. Satoshi sells rock drilling machines which are used in quarries and open pit
mines throughout South Africa.

After a successful exhibition at the Electra Mining Africa show during 20.27, Satoshi received various
queries from companies operating in Botswana relating to the rock drilling machines. Satoshi imports
machines that can withstand extreme temperatures from South Korea.

The profit before tax for the year ended 31 December 20.27 is R32 560 000 before processing the
necessary journals to account for the transactions below. The balance of share capital and retained
earnings at 1 January 20.27 is R243 678 000 and R56 780 000, respectively.

1. Rock drilling machines imported

To ensure that Satoshi will be able to meet the increased demand for the rock drilling machines
that can withstand extreme temperatures, Satoshi decided on 1 September 20.27 to import three
rock drilling machines at a cost of KRW 204 000 000 each. The official currency of South Korea
is the South Korean Won (KRW). The machines were delivered to Satoshi on 1 October 20.27.
Control of the machines passed to Satoshi on delivery date.

The foreign creditor was payable as follows:

KRW
1 December 20.27 408 000 000
1 February 20.28 204 000 000
612 000 000

The above repayment terms are normal credit terms.

On 1 October 20.27 Satoshi entered into a five-month forward exchange contract (FEC) for the
KRW 204 000 000, payable on 1 February 20.28, to hedge itself against foreign currency risk at a
forward rate of KRW 1 = R0,01. Satoshi does not apply hedge accounting in terms of IFRS 9
Financial Instruments.

64
 The applicable exchange rates were as follows:

Spot rate Forward rate

R1 = KRW R1 = KRW

1 September 20.27 110

1 October 20.27 102
1 December 20.27 95 90 (2 months)
31 December 20.27 90 85 (1 month)
1 February 20.28 98

One of the machines was sold to a new Botswana client on 1 December 20.27 for R2 500 000
and the other two machines were sold in March 20.28.

2. Disposal of investment

Satoshi holds an investment in Nakamoti Ltd bonds with an amortised cost of R5 600 000 on
31 December 20.26. These bonds were held within a portfolio of investments that Satoshi
manages in order to collect contractual cash flows of interest and principal. The bonds have an
effective interest rate of 10% per annum, interest is payable annually and the bonds are
redeemable at par value on 31 December 20.20. On 1 July 20.27, Satoshi decided to sell the
bonds for R5 950 000 to finance capital expenditure. The bonds were never credit impaired and
no credit losses were expected throughout the life of the financial asset.

3. Share-based payment arrangement

On 1 January 20.26 Satoshi entered into an arrangement with a key senior employee. The terms
of the arrangement are as follows:

• Satoshi grants the employee the right to receive either a cash payment equal to the value of
800 shares or 900 actual shares.
• Satoshi has the choice of settlement.
• The grant is conditional on the completion of two years' service.
• If shares are issued, they should be held for two years after vesting date.

Satoshi does not have a present obligation to settle in cash. It was expected that the senior
employee will remain with the company until 31 December 20.27. The fair value of one Satoshi
share was as follows on the respective dates:

Fair value with a two-year post-

Date Fair value
vesting transfer restriction
R R
1 January 20.26 198 190
31 December 20.26 211 200
31 December 20.27 220 210

On 31 December 20.27 Satoshi decided to elect the choice of settlement with the lower fair value
as at 31 December 20.27.

65
4. Investment in debt instrument

On 1 January 20.27 Satoshi acquired an investment in Redid Ltd bonds at a fair value of
R3 000 000. No transaction costs were paid. The bonds pay coupon interest of R400 000 on
31 December of each year and will be redeemed on 31 December 20.29 at a face value of
R2 500 000. Satoshi holds these bonds to collect the contractual cash flows and, when an
opportunity arises, it will sell the bonds to re-invest the cash in other financial assets at a higher
return. Therefore, both collecting contractual cash flows and selling the bonds are integral in
achieving the business model’s objective. On 1 January 20.27 the bonds were not credit impaired
and no credit losses were expected. However, on 31 December 20.27 the credit risk had
increased significantly since initial recognition, but the bonds were not credit impaired. The fair
value of the bonds on 31 December 20.27 is R2 500 000.

The financial manager of Satoshi provided you with the following schedule of the assessed credit
risk and estimated expected credit losses of its investment in the Redid Ltd bonds:

Date Assessed credit risk 12-month Lifetime

expected expected
credit losses credit losses
R R

31 December 20.27 High (not credit impaired) 32 000 500 000

PART II 12 marks

GreenBottles Ltd is a manufacturer of water bottles and jugs that are made with economic-friendly fibre.
The company was incorporated in 20.21 and has a 31 December year end. You are the newly appointed
financial manager of GreenBottles Ltd. The financial director sent you an extract of the statement of
financial position, the accounting policies and notes relating to the financial assets of GreenBottles Ltd.

GreenBottles Ltd

Extract from the statement of financial position as at 31 December 20.27

20.27
Notes
R
Non-current assets
Financial assets measured at fair value through OCI 4 500 000
Financial assets measured at amortised cost 5 600 000
Current assets
Trade and other receivables 6 380 000

66
Extract from the notes for the year ended 31 December 20.27

1. Accounting policies

1.1 Trade receivables

Trade receivables consist of the day-to-day trade receivables only, and do not contain a significant
financing component.

1.2 Allowance for credit losses for trade receivables

The allowance for credit losses is assessed each year based on the following:

• If the credit risk has not increased significantly, 12-month expected credit losses are used.
• If the credit risk increased significantly, the loss allowance will be equal to the lifetime
expected credit losses.
• Interest is calculated using the effective interest rate method.

4. Financial assets at fair value through other comprehensive income

These investments consist of shares in two companies listed on the Johannesburg Stock
Exchange (JSE). At initial recognition, the entity irrevocably elected to measure these equity
instruments at fair value through other comprehensive income in terms of IFRS 9.4.1.4. Both
companies declared dividends during the financial year.

5. Financial assets measured at amortised cost

The investments in financial instruments comprise the following:

Type of instrument R
1 000 Bonds in Morning Ltd 247 000
800 Bonds in Flowers Ltd 190 000
100 Bonds in Rose Ltd 163 000
Total 600 000

The contractual cash flows received from bonds consist solely of payments of principal and interest
on the principal amount outstanding. The funding needs of GreenBottles Ltd are predictable and
the maturity of the investments in bonds is matched to the estimated funding needs of
GreenBottles Ltd. As per the policy of the portfolio, if the bonds fall below the F1 rating in terms of
Fitch Ratings, the risk of collecting contractual cash flows will become high. Under such
circumstances the bonds will be disposed of. The bonds in Flowers Ltd were disposed of during
the year, as their ratings dipped below F1.

6. Trade and other receivables

R
Trade receivables 400 000
Less: Allowance for credit losses 20 000
Net trade receivables 380 000

67
Additional information

• All risk related disclosure has correctly been disclosed in a separate note in the financial
statements and is correct in terms of IFRS 7 Financial Instruments: Disclosure.
• The financial director is of the opinion that the portfolio of investment in bonds (refer to disclosure
note 5) should be reclassified from amortised cost to financial assets measured at fair value
through other comprehensive income, because the bonds will probably not be held to maturity due
to the possible increase in credit risk or unanticipated funding needs of GreenBottles Ltd.

68
QUESTION 4

YOU HAVE 60 MINUTES TO ANSWER THIS QUESTION

REQUIRED
Marks

PART I

(a) Provide the journal entries to account for the investment in Nakamoti Ltd bonds (refer 5
to note 2) in the financial statements of Satoshi Ltd for the year ended
31 December 20.27.

Please note:
• Journal narrations are not required.

(b) Calculate the profit before tax in the financial statements of Satoshi Ltd for the year 13
ended 31 December 20.27.

(c) Present the information provided of Satoshi Ltd in the statement of changes in equity 8
for the year ended 31 December 20.27.

Communication skills: presentation and layout 2

Please note:
• Total columns are not required.
• Comparative amounts are not required, but opening balances at
1 January 20.27 are required.

PART II

(a) Discuss in terms of IFRS 9 Financial Instruments whether the portfolio of bonds (refer 4
to disclosure note 5) should be reclassified as financial assets measured at fair value
through other comprehensive income.

(b) Write an email to the financial director discussing your concerns in terms of IFRS 7 7
Financial Instruments: Disclosures and IFRS 9 Financial Instruments relating to the
following notes provided:

1. Accounting policies
4. Financial assets measured at fair value through other comprehensive income
6. Trade and other receivables

Communication skills: layout and conclusion 1

69
QUESTION 4 – Suggested solution

PART I

(a) Journal entries

Dr Cr
R R
1 July 20.27
J1 Financial asset at amortised cost (SFP) 280 000 (½)
Interest income (P/L) (5 600 000 x 10% x 6/12) 280 000 (1½)
J2 Bank (SFP) 5 950 000 (1)
Financial asset at amortised cost (SFP) 5 880 000 (1)
(5 600 000 + 280 000)
Gain on disposal (P/L) 70 000 (1)
(5)

(b) Profit before tax

R
Profit given 32 560 000 (½)
Investment in bonds sold (from a):
- Interest income 280 000 (½)
- Gain on disposal 70 000 (½)
Inventory imported:
Foreign exchange difference (loss): creditor remeasure 1 December (442 105) (2)
(KRW 612 000 000/102 = R6 000 000) – (KRW 612 000 000/95 =
R6 442 105)
Foreign exchange difference (loss): creditor remeasure at closing (119 299) (2)
31 December (KRW 204 000 000/95 = R2 147 368) –
(KRW 204 000 000/90 = R2 266 667)
Cost of sales (KRW 204 000 000/102) (2 000 000) (1)
Sales 2 500 000 (½)
FEC:
Fair value gain of FEC ((KRW 204 000 000/100 (1/0,01) or (KRW 204 000 360 000 (2)
000x0.01) = R2 040 000)) – (KRW 204 000 000/85 = 2 400 000)
Share-based payment:
Employee benefit cost (900 x 190 x ½) (85 500) (1)
Investment in debt instrument:
- Interest income (3 000 000 x 8,21%1) 246 298 (2)
1 Effective interest rate (PV = (3 000 000); PMT = 400 000; FV =

2 500 000; N = 3)
- Expected credit losses (500 000) (1)
Total 32 869 394
(13)

70
(c) Statement of changes in equity of Satoshi Ltd for the year ended 31 December 20.27

Fair value Expected Share-

Share Retained adjustments credit based
capital earnings on debt losses payment
instruments reserve reserve
R R R R R
Balance at
1
1 January 20.27 243 678 000 56 780 000 85 500 (2)
Share-based payment
(from b) 85 500 (½)
Share-based payment
settlement 2&3(5 000) 3(171 000) (3)
Total comprehensive
income
- Profit for the year (½)
(from (b)) 32 869 394
- Other comprehen-
sive income (346 298)4 500 000 (2)
Balance at
31 December 20.27 243 678 000 89 644 394 (346 298) 500 000 -
Total (8)
Communication skills: Logical flow and conclusion (2)

1 (900 x 190 x ½) [1]

2 Lowest fair value (cash option): cash 800 x 220 = 176 000 or equity 900 x 210 = 189 000 [2]
3 176 000 – 171 000 (85 500 + 85 500) = 5 000 [1]
4 (2 500 000 – 2 846 298 (3 000 000 + 246 298 (from (b) – 400 000)) [1½]

71
PART II

(a) Portfolio of bonds

In terms of IFRS 9.4.1.2A a financial asset shall be measured at fair value through other
comprehensive income if both of the following conditions are met:
- The financial asset is held within a business model whose objective is achieved by
both collecting contractual cash flows and selling financial assets.
- The contractual terms of the financial asset give rise to cash flows that are solely
payments of principal and interest on the principal amount outstanding.
In terms of IFRS B4.1.3, although the objective of an entity's business model may be to
hold assets in order to collect contractual cash flows, the entity need not hold all of those
assets until maturity. Thus, an entity's business model can be to hold financial assets to
collect contractual cash flows, even when sales of financial assets occur or are expected
to occur in the future.
In terms of IFRS 9 B4.1.3A the business model may be to hold assets to collect
contractual cash flows, even if the entity sells the financial assets when there is an
increase in the credit risk. To determine whether there has been an increase in the credit
risk, the entity considers reasonable and supportable information, including forward
looking information. Selling a financial asset because it no longer meets the credit criteria
specified in the entity's document investment policy is an example of a sale that has
occurred due to an increase in credit risk.
In terms of IFRS 9 B4.1.4B a business model whose objective it is to both collect
contractual cash flows and sell financial assets will typically involve a greater frequency
and value of sales. This is because the selling of the financial asset is integral to achieving
the business model’s objective, instead of being only incidental to it.
When determining cash flows that will be realised, it is necessary to consider the
frequency, value and timing of sale in prior periods. (½)
Fitch Ratings are provided by banks and can be relied upon as being reasonable and
used as support to assess the credit risk of the bonds, as they are external ratings done
by a 3rd party. (1)
In terms of IFRS 9.4.4.1, when and only when an entity changes its business model for
managing financial assets, it shall reclassify all affected financial assets in accordance
with paragraphs 4.1.1 – 4.1.1.4.
GreenBottles did not change its business model, as contractual cash flows received is
solely payments of principal and interest. (½)
It is not GreenBottles’ intention to sell the bonds. The bonds are sold if the risk of recovery
of contractual cash flows increases. (½)
GreenBottles sells the bonds only when there is an increase in the credit risk and the
Fitch ratings go below F1, indicating that the risk of non-collection of contractual cash
flows are high. Therefore, the sales of bonds are rather incidental to the credit risk
increasing and not of greater frequency. (1½)
Although the possibility exists of GreenBottles Ltd selling the bonds before maturity, it
does not make it the objective of the business model to sell the assets. The sales are
infrequent due to credit risk management or resulting from unanticipated funding needs. (1)
Therefore, the portfolio of bonds should not be classified to be measured at fair value
through other comprehensive income, but should be measured at amortised cost (1)
Total (6½)
Maximum (4)

72
(b)
To: Financial director
From: Financial manager
Re: Concerns regarding specific notes to the financial statements
Good day
As requested, I have reviewed the financials provided. Please find my concerns listed below:
1. Accounting policies
In terms of IFRS 7.21, in accordance with paragraph 117 of IAS 1, an entity discloses its
significant accounting policies comprising the measurement basis used in preparing the
financial statements.
Only the accounting policy of trade receivables is given - there is no policy note that
includes other financial assets. (1)
Trade receivables and allowances for credit losses policy note
In terms of paragraph 5.5.15 of IFRS 9 an entity shall always measure the loss
allowance at an amount equal to lifetime expected credit losses for:
(a) trade receivables or contract assets that result from transactions that are within
the scope of IFRS 15, and that
(b) do not contain a significant financing component in accordance with IFRS 15
As the trade receivables do not contain a significant financing component, the allowance
for credit losses is the amount equal to lifetime expected credit losses (simplified
approach) and, therefore, the policy note should be corrected and exclude the 12 month
credit losses component. (1)
The policy should not include interest calculations, as there is no significant financing
component included in the trade receivables. (1)
4. Financial asset at fair value through OCI
In terms of IFRS 7.11 A, if an entity has designated investments in equity instruments to
be measured at fair value through other comprehensive income, as permitted by
paragraph 5.7.5 of IFRS 9, it shall disclose
(a) which investments in equity instruments have been designated to be measured at
fair value through other comprehensive income.
GreenBottles Ltd correctly stated that the investments are in shares of companies
listed on the JSE, but did not name the companies. (½)
(b) the reason for using this presentation alternative.
No valid reason is provided for electing to measure the equity instruments at fair
value through other comprehensive income. (½)
(c) The fair value of each such investment at the end of the reporting period.
The fair value of each of the investments is not disclosed as required by IFRS 7. (½)
(d) Dividends recognised during the period.
There is no disclosure regarding the dividends received by GreenBottles Ltd from
the investments designated as measured through other comprehensive income. (½)
6. Trade and other receivables
GreenBottles Ltd needs to explain the changes in the loss allowance and the reasons for
those changes. An entity shall provide, by class of financial instrument, a reconciliation
from the opening balance to the closing balance of the loss allowance in a table, showing
separately the changes during the period for the loss allowance measured at an amount
equal to lifetime expected credit losses for trade receivables, contract assets or lease
receivables for which the loss allowance is measured in accordance with paragraph
5.1.15 of IFRS 7.25H(b)(iii)9.

73
 There is no reconciliation performed and disclosed for the lifetime expected credit losses
from the opening to the closing balances. (½)
In terms of IFRS 7.35G an entity shall explain the inputs, assumptions and estimation
techniques used to recognise the expected credit losses. For this purpose, an entity shall
disclose
(a) The basis of inputs and assumptions and the estimation techniques used to
(i) measure the lifetime expected credit losses
(ii) determine whether a financial asset is a credit impaired financial asset
(b) how forward-looking information has been incorporated into the determination of
expected credit losses, including the use of macroeconomics information
(c) changes in the estimation techniques or significant assumptions made during the
reporting period and the reasons for those changes.
Greenbottles did not disclose any basis of input, assumptions and estimation, any forward-
looking information that has been incorporated into the determination of the expected credit
losses, any changes in the estimation technique or significant assumptions, and the reasons
for those changes. (1½)

I trust that you will find the above comments helpful.

Kind Regards

Financial Manager
Total (7)
Communication skills: logic and conclusion (1)

74
QUESTION 5 20 marks

YOU HAVE 8 MINUTES TO READ THIS QUESTION

Shantui Construction Ltd (Shantui) is a South African company founded on 1 July 20.0. Shantui
specialises in equipment used in the construction industry, such as bulldozers, industrial vehicles and
concrete mixers. Shantui owns the equipment and leases the equipment to their customers operating in
the construction industry in South Africa. Shantui’s financial year end is 31 December.

The financial manager requested your assistance with the following transactions that have not been
accounted for in the financial statements of Shantui for the year ended 31 December 20.25.

1. Foreign loan

On 1 September 20.25 Shantui borrowed CNY800 000 from its holding company in China. The
currency of China is the Chinese yuan (CNY).

The loan from the holding company was utilised to finance the purchase of new bulldozers
acquired in South Africa for a total amount of R1 500 000. The contract term of the loan agreement
between Shantui and the holding company is four years. The loan agreement stipulates that
annual capital instalments of CNY200 000 are payable on 31 August of each year, commencing
on 31 August 20.26. The interest rate on the loan equals a market related interest rate of 9% per
annum. Interest is payable six-monthly in arrears, commencing on
29 February 20.26.

On 1 October 20.25 the directors of Shantui expected adverse foreign currency fluctuations. On
this date the directors of Shantui decided to enter into an eleven-month forward exchange contract
(FEC) at a forward rate of R2 as part of their risk management strategy in respect of the first capital
instalment of the loan.

Shantui does not apply hedge accounting.

The exchange rates at the relevant dates are as follows:

Spot rate Forward rate

CNY1 = R CNY1 = R

1 September 20.25 1,95

1 October 20.25 2,05 2,00 (11 months)
31 December 20.25 2,20 2,10 ( 8 months)
29 February 20.26 2,15 2,08 ( 6 months)

Average for period 1/09/20.25 – 31/12/20.25 2,02

Average for period 1/01/20.26 – 29/02/20.26 2,10

The purchase of the bulldozers, as well as the related depreciation, was correctly accounted for
in the financial statements of Shantui Ltd for the year ended 31 December 20.25.

75
2. Allowance for expected credit losses

Shantui acquired an investment in listed bonds on 1 January 20.25. The listed bonds are held by
Shantui within a business model whose objective is to collect contractual cash flows of interest
and the principal amount. The classification and measurement of the investment in listed bonds
were correctly accounted for in the financial statements of Shantui for the year ended
31 December 20.25.

The financial manager of Shantui is unsure about the calculation and measurement of the loss
allowance for expected credit losses of the investment in listed bonds for the year ended
31 December 20.25. He asked for your assistance in this regard. The financial manager provided
you with the following schedule from the company’s actuary containing the information relevant to
the bonds:

ABC Actuaries

Date: 5 January 20.26

Dear financial manager of Shantui Ltd

We assessed the investment in listed bonds acquired by you on 1 January 20.25 and determined
the following:

Credit risk on 31 December 20.25 Low risk

Present value on 31 December 20.25 of contractual cash flows on the listed R920 520
bonds in terms of the bond contract.
Present value on 31 December 20.25 of expected contractual cash flows on the R899 320
listed bonds over the contract term of the bonds, based on the risk or probability
of default occurring over the expected life of the bonds.

We estimate that there is a very low possibility of a credit loss occurring on the
listed bonds.
Probability of default occurring between 1 January 20.26 – 31 December 20.26 0,5%

In our assessment, above, we made use of reasonable and supportable information about past
and current conditions, as well as forecasts on the listed bonds available to us. We trust the
above calculation will assist with your accounting of the listed bonds.

Yours sincerely
Mrs. Jacobs

Additional information

• Assume all amounts are material.

• The normal income tax rate is 27%.

76
QUESTION 5

YOU HAVE 30 MINUTES TO ANSWER THIS QUESTION

REQUIRED

Marks
(a) Prepare the journal entries for the financial year ended 31 December 20.25 in respect 10
of transaction 1 in the records of Shantui Construction Ltd.

Please note:
• Ignore journal narrations.
• Ignore any normal income tax implications.
• Ignore the time value of money.

(b) Discuss the recognition and measurement of the expected credit losses on the 9
investment in listed bonds in the financial statements of Shantui Construction Ltd for
the year ended 31 December 20.25 in accordance with IFRS 9 Financial Instruments.
Your answer should include calculations.

Communication skills: logical argument 1

Please note:

• Ignore all Value Added Taxation (VAT) implications.

• Round off all amounts to the nearest rand.
• Your answer should comply with the International Financial Reporting Standards
(IFRS).

77
QUESTION 5 - Suggested solution

(a) Journal entries

Dr Cr
R R
1 September 20.25
J1 Bank (SFP) (CNY800 000 x 1,95) 1 560 000 (1½)
Foreign loan (SFP)) 1 560 000 (½)
Recognise loan received at spot rate
31 December 20.25
J2 Foreign exchange difference (P/L) 200 000 (1½)
[CNY800 000 x (2,20 – 1,95)]
Foreign loan (SFP) 200 000 (½)
Remeasure foreign loan to spot rate at reporting date
J3 Finance costs (P/L)
(CNY800 000 x 9% x 4/12 = 24 000 x 2,02) 48 480 (1½)
Accrued interest (SFP)
(CNY800 000 x 9% x 4/12 x 2,20) 52 800 (1½)
Foreign exchange difference (P/L) 4 320 (1)
Year end accrual for interest for four months ended
31 December 20.25
J4 FEC Asset (SFP) [CNY200 000 x (2,10 – 2,00)] 20 000 (1½)
Fair value adjustment (P/L) 20 000 (½)
Remeasure FEC (derivative financial instrument) at year
end
Total (10)

(b) Recognition and measurement of expected credit losses

Recognition
Shantui is required to recognise a loss allowance for expected credit losses on financial
assets measured at amortised costs (IFRS 9.5.5.1). (1)

The investment in listed bonds is classified as a financial asset measured at amortised

cost, since it is held within a business model whose objective is to collect contractual cash
flows of interest and the principal amount (IFRS 9.4.1.2). (1)

At each reporting date, Shantui should assess whether the credit risk of listed bonds
increased significantly since the initial recognition of the listed bonds (IFRS 9.5.5.9). (1)

This assessment of the increase in credit risk determines if a loss allowance equal to an
amount of lifetime expected credit losses or 12-month expected credit losses is
recognised on the listed bonds (IFRS 9.5.5.3 and IFRS 9.5.5.5). (1)

An entity may assume that the credit risk on a financial instrument has not increased
significantly if the financial instrument is determined to have a low risk at reporting date
(IFRS 9.5.5.10).

The actuary indicated that the listed bonds had a low risk on 31 December 20.25. For this (½)
reason, Shantui may assume that the credit risk on the listed bonds did not increase
significantly since the initial recognition of the listed bonds. (½)

Based on the above, a loss allowance for expected credit losses equal to 12-month (1)
expected credit losses should be recognised on the investment in listed bonds.

78
Measurement

In terms of IFRS 9.5.5.17 Shantui should measure the expected credit losses on the
bonds in a way that reflects
• an unbiased and probability-weighted amount that is determined by evaluating
a range of possible outcomes.

Even though the actuary determined that there is a very low possibility of a
credit loss occurring on the listed bonds, the risk or probability that a credit loss
may occur still has to be considered. (1)

The actuary used a probability weighted amount when calculating the expected
cash flows of the listed bonds. (½)

• The time value of money.

The actuary used the contract term of the listed bonds to determine the present
value of the expected contractual cash flows. (½)

• Reasonable and supportive information that was available to the actuary of

Shantui without undue cost or effort about past events, current conditions and
forecasts of future economic conditions. (1)

• The loss allowance for expected credit losses on the listed bonds, which are
determined as follows:
R
Present value of contractual cash flows on 31 December 20.25 920 520 (½)
Present value of expected cash flows on 31 December 20.25 899 320 (½)
Lifetime expected credit losses 21 200

Loss allowance equal to 12-month expected credit losses

(21 200 x 0,5%) 106 (1)
Total (11)
Maximum (9)
Communication skills: logical argument (1)

79
QUESTION 6 15 marks

YOU HAVE 6 MINUTES TO READ THIS QUEGSTION

Exclusive Clocks Ltd is a renowned clock maker in South Africa. Exclusive Clocks Ltd produces a range
of beautiful clocks based on English clock making techniques and the latest technology in the industry.
In order to produce authentic and high-quality clocks, Exclusive Clocks Ltd imports the necessary clock
parts from England. The assembly of the clocks and engraving of dials take place at the assembly plant
of Exclusive Clocks Ltd in Cape Town.

You have been asked to assist the accountant of Exclusive Clocks Ltd in finalising the financial
statements of Exclusive Clocks Ltd for the year ended 30 June 20.25. The outstanding issues on which
he requires your assistance are explained below:

1. Import of clock parts

On 31 December 20.24 Exclusive Clocks Ltd received an order from a major Johannesburg clock
wholesaler for mantel clocks. To meet the required quantity of clocks for this order, Exclusive
Clocks Ltd placed a non-cancellable order for the required clock parts from its supplier in England
on 31 December 20.24 for an amount of £20 400. Due to the quantity of clock parts ordered and
the risk it holds for foreign currency fluctuations, Exclusive Clocks Ltd entered into a four-month
forward exchange contract (FEC) at a forward rate of £1 = R16,60 for the full amount payable.
Exclusive Clocks Ltd entered into the FEC on the same date as the order was placed. The supplier
in England requires settlement of the outstanding purchase price on 30 April 20.25. The clock
parts were shipped free on board on 28 February 20.25 and arrived in Cape Town on
31 March 20.25.

The following exchange rates are applicable:

Spot rate Forward rate

£1 = R £1 = R
31 December 20.24 16,25 16,60 (4 month FEC)
31 January 20.25 16,90 17,00 (3 month FEC)
28 February 20.25 17,45 17,20 (2 month FEC)
31 March 20.25 17,85 17,60 (1 month FEC)
30 April 20.25 18,10

Exclusive Clocks Ltd does not apply hedge accounting in terms of IFRS 9.

2. Investment in listed bonds

On 1 July 20.23 Exclusive Clocks Ltd invested in listed bonds in Money Dreams Ltd. On this date
Exclusive Clocks Ltd estimated the 12-month expected credit losses on the bonds at an amount
of R35 000. The bonds were purchased on the following terms:

Maturity date 30 June 20.26

Coupon interest rate 6% per annum
Interest payment date 30 June
Nominal value per bond R12 000
Number of bonds purchased 150
Redemption value At nominal value

80
 On 30 June 20.24 Exclusive Clocks Ltd assessed the credit risk of the bonds to estimate the
expected credit losses at reporting date. During this assessment the directors of
Exclusive Clocks Ltd obtained information that Money Dreams Ltd was in financial distress.

Exclusive Clocks Ltd determines that the credit risk of the bonds increased significantly since
recognition of the bonds. Consequently, Exclusive Clocks Ltd measures the lifetime expected
credit losses on 30 June 20.24 at R125 000.

On 30 June 20.25 Exclusive Clocks Ltd determines that the credit risk of the bonds has still
increased significantly since initial recognition and measures the lifetime expected credit losses
on this date at an amount of R165 000.

Additional information

• Assume all amounts are material.

81
QUESTION 6

YOU HAVE 23 MINUTES TO ANSWER THIS QUESTION

REQUIRED

Marks
(a) Prepare the journal entries to account for the transactions relating to the importing of 11
clock parts in the financial statements of Exclusive Clocks Ltd for the year ended
30 June 20.25.

Please note:
• Ignore journal narrations but include journal dates.
• Ignore the time value of money.

(b) With reference to the investment in the listed bonds, disclose the changes in the loss 3
allowance (allowance for expected credit losses) of the bonds in the financial
statements of Exclusive Clocks Ltd for the year ended 30 June 20.25 in terms of IFRS
7.35H and the illustrated example contained in IFRS 7.IG20B. Comparative
information is required.

Communication skills: presentation and layout 1

Please note:
• Round all amounts off to the nearest rand.
• Ignore normal income tax implications.
• Ignore Value Added Taxation (VAT) implications.
• Your answer must comply with International Financial Reporting Standards (IFRS).

82
QUESTION 6 - Suggested solution

(a) Journal entries

Dr Cr
R R
28 February 20.25
J1 Inventory (SFP) (£20 400 x 17,45) 355 980 (1)
Creditor (SFP) 355 980 (½)
Recognise inventory at spot rate on transaction date
30 April 20.25
J2 Foreign exchange difference (P/L) (£20 400 x (18,10 – 17,45)) 13 260 (1½)
Creditor (SFP) 13 260 (½)
Remeasure creditor to spot rate on settlement date (loss)
J3 FEC asset (SFP) (£20 400 x (18,10 – 16,60) 30 600 (1½)
Fair value adjustment (P/L) 30 600 (½)
Remeasure FEC to fair value on settlement date (gain)
J4 Creditor (SFP) (£20 400 x 18,10) 369 240 (1)
FEC asset (SFP)
(12 240 + 18 360) or (£20 400 x (18,10 – 16,60)) 30 600 (1½)
Bank (SFP) (£20 400 x 16,60) 338 640 (1)
Derecognition of FEC and payment of creditor
Total (11)

(b) EXCLUSIVE CLOCKS LTD

NOTES OF THE YEAR ENDED 30 JUNE 20.25

15. Listed bonds – loss allowance

12-month expected Lifetime expected
credit losses credit losses
R R

Loss allowance at 1 July 20.23 - -

New bonds originated 35 000 (½)
Transferred to credit impaired (35 000) 35 000 (1)
financial assets
Changes in risk parameters 90 000 (½)
Loss allowance at 30 June 20.24 - 125 000
Changes in risk parameters 40 000 (½)
Loss allowance at 30 June 20.25 - 165 000 (½)
Total (3)
Communication skills: presentation and layout (1)

83
QUESTION 7 25 marks

YOU HAVE 9 MINUTES TO READ THIS QUESTION

You are the financial manager of Ultra Motors Ltd (Ultra Motors). Ultra Motors is a company that
manufactures and sells vehicles and vehicle component parts. Most of Ultra Motors products are
exported to Australia and America, although some products are sold in the local market. Ultra Motors
manufacturing plants are located in Port Elizabeth and most of the exports are made via the Port
Elizabeth harbour.

Ultra Motors’ financial year end is 30 September, and you are currently compiling the financial
statements for the year ended 30 September 20.22. These financial statements must be submitted for
approval at the directors’ meeting on 15 November 20.22.

Except for transaction 1 which was correctly accounted for, transactions 2 to 4 must still be accounted
for in the financial statements of Ultra Motors for the year ended 30 September 20.22.

Transaction 1: Import of machine

On 1 September 20.22 a non-cancellable order was placed to import a machine from Australia. The
purchase price of AUS$ 99 000 was paid on 1 December 20.22. The machine was shipped free-on-
board on 1 November 20.22. Ultra Motors obtained control of the machine on 1 November 20.22.

On 1 September 20.22 Ultra Motors entered into a forward exchange contract (FEC) for an amount of
AUS$ 99 000 in anticipation of the future import. The FEC expired on 1 November 20.22 and was not
renewed.

Ultra Limited does not apply hedge accounting in terms of IFRS 9.

The exchange rates applicable were as follows:

2 months 1 months
Spot rate
FEC rate FEC rate
1 AUS$=R 1 AUS$=R 1 AUS$=R
1 September 20.22 8,00 8,18 8,20
30 September 20.22 8,11 8,34 8,32
1 November 20.22 8,30 8,48 8,45
1 December 20.22 8,35 8,58 8,54

Transaction 2: Loan incurred

Ultra Motors borrowed R1 000 000 from Altex Ltd (Altex) on 1 October 20.7. Interest amounting to
R100 000 is payable annually on 30 September in respect of the loan. The repayment terms state that
the loan capital must be repaid at a premium of R200 000 on 30 September 20.22 (to compensate for
the low nominal interest rate compared to a market-related interest rate on a similar loan). You may
assume that the loan and the related interest were treated correctly in the accounting records of
Ultra Motors up to and including 30 September 20.22. The loan amounted to R1 200 000 in Ultra Motors’
books on 30 September 20.22.

84
During September 20.22 Ultra Motors was in the process of expanding its business operations. To
reserve funds for the expansion, Ultra Motors renegotiated the terms of the repayment of the loan with
Altex. Ultra Motors proposed the following terms of the redemption of the loan:

• To redeem the loan by issuing 120 000 preference shares of Ultra Motors to Altex on
30 September 20.22.
• Preference dividend payments are within the discretion of Ultra Motors.
• The preference shares will be converted on 30 September 20.24, into the ratio of two ordinary
shares for every one preference share held.

Altex accepted the proposal on the basis of growing their investment portfolio. The loan was redeemed
on 30 September 20.22 by Ultra Motors issuing 120 000 preference shares to Altex. The redemption of
loan has not been accounted for by Ultra Motors. You may assume that the preference shares are
correctly classified as equity instruments in terms of IAS 32 Financial Instruments: Presentation and that
the total fair value thereof amounted to R1 400 000 on 30 September 20.22.

SARS regards the redemption of the loan (by the issue of preference shares) as capital in nature and,
therefore, allows no tax deductions in respect of the redemption of the loan.

Transaction 3: Issue of convertible debentures

To generate additional cash, Ultra Motors issued a total of 100 000 R10 debentures at a discount of
20% on 1 January 20.22. The debentures carry a coupon interest rate of 12% per annum, which is
payable annually on 31 December. The compulsory convertible debentures will be converted into
Ultra Motors ordinary shares in the ratio of one debenture for two ordinary shares on
31 December 20.28. There is no option for cash settlement. A market-related interest rate on similar
debentures without conversion rights amounted to 9% per annum on 1 January 20.22. No entries have
been made in respect of this transaction. Assume that SARS accepts the amortised cost of the
debentures as the tax base of the debentures. Ultra Motors received a tax directive from SARS indicating
that future taxable profits on the debentures will be taxed at 27%.

Transaction 4: Investment in shares

Ultra Motors invested in 200 000 ordinary shares of Speedfast Ltd (Speedfast) on 1 October 20.21,
which represents 10% of the issued shares of Speedfast. Ultra Motors is dependent on Speedfast for
the supply of its products and, therefore, regards this investment as a long-term strategic investment.
On initial recognition of the investment in Speedfast, the management of Ultra Motors elected to
recognise changes in the fair value of the equity instrument in other comprehensive income using the
mark-to-market reserve.

The investment was acquired at fair value when the share price of Speedfast’s ordinary shares was
R6,20 per share. Transaction costs directly attributable to the acquisition of the investment amounted
to R23 000. The fair value of Speedfast’s ordinary shares on 30 September 20.22 amounted to R8,45
per share. For tax purposes the transaction costs are included in the tax base of the investment.

Additional information

• The issued share capital and retained earnings balance of Ultra Motors on 1 October 20.21
amounted to R3 000 000 and R2 340 000, respectively.
• Ultra Motors’ profit after tax amounted to R3 765 000 for the year ended 30 September 20.22,
before considering the redemption of the loan in transaction 2 and transactions 3 and 4.
• The normal income tax rate is 27% and capital gains tax inclusion rate is 80%.

85
QUESTION 7

YOU HAVE 38 MINUTES TO ANSWER THIS QUESTION

REQUIRED

Marks
(a) Prepare the journal entries for the financial years ended 30 September 20.22 AND 11
30 September 20.23 in respect of transaction 1 in the records of Ultra Motors Ltd.

Please note:
• Ignore depreciation journals in respect of the machinery.
• Journal narrations are not required.
• Ignore any normal income tax implications.
• Ignore the time value of money.

(b) Prepare the statement of changes in equity of Ultra Motors Ltd for the year ended 12
30 September 20.22. The total column and comparative figures are not required.

Communication skills: presentation and layout 2

86
QUESTION 7 - Suggested solution

(a) Journal entries

Dr Cr
20.22 year
R R
30 September 20.22
J1 FEC asset (SFP) [(8,32 – 8,18) x $99 000] 13 860 (1½)
Fair value adjustment (P/L) 13 860 (½)
Fair value adjustment of FEC at year end
20.23 year
1 November 20.22
J2 Fair value adjustment (P/L) [(8,30 – 8,32) x $99 000] 1 980 (½)
FEC asset (SFP) 1 980 (1½)
Fair value adjustment of FEC on expiry date.
J3 Machine (SFP) [8,30 x $99 000] 821 700 (1)
Creditors (SFP) 821 700 (½)
Recognition of asset and creditor on transaction date
J4 Bank (SFP) [(8,30 – 8,18) x $99 000] 11 880 (1½)
FEC asset (SFP) 11 880 (½)
Settlement of FEC on expiry date
1 December 20.22
J5 Foreign exchange differences (P/L) 4 950 (1½)
[(8,35 – 8,30) x $99 000]
Creditors (SFP) 4 950 (½)
Restatement of creditor to spot rate on payment date
J6 Creditor (SFP) [99 000 x 8,35] 826 650 (1)
Bank (SFP) 826 650 (½)
Settlement of creditor
Total (11)

EXAM TECHNIQUE

When preparing journals, always date your journals. This demonstrates to the examiner
that you understand the occurrence of the specific dates of transactions.

87
(b) ULTRA MOTORS LTD

STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 30 SEPTEMBER 20.22

Convertible
Ordinary Mark-to
Preference Retained debentures
share market
share capital earnings equity
capital reserve
component
R R R R R

Balance at 1 October 20.21 3 000 000 - 2 340 000 - (1)

Total comprehensive income for the year
- profit for the year [C1] - - 3 535 240 - (5½)
[C3]334
- other comprehensive income - - - - 768 (3½)
Issue of preference shares [C2] - 1 400 000 - - (1)
Issue of convertible debentures [C4] - - - 143 1141 (1)
Balance at 30 September 20.22 3 000 000 1 400 000 5 875 240 143 114 334 768
Total (12)
Communication skills: presentation and layout (2)

1196 046 [C4] x 73% = 143 114

CALCULATIONS

C1. Profit for the year

Profit after tax (given) 3 765 000 [½]

Loss on redemption of loan (IFRIC 19) [C2] (200 000) [1]
Interest on the liability portion of the compulsory convertible debentures (40 767) [3]
[C4]
Tax on the interest (40 767 x 27%) 11 007 [1]
3 535 240
[5½]
C2. Loss on redemption of loan

IFRIC 19

Loan outstanding (given) 1 200 000 [½]

Preference shares issued at fair value (1 400 000) [½]
Loss on redemption of loan (P/L) (200 000)
[1]

The loss is not deductible for tax purposes, since it is capital in nature. It is, therefore, considered
in the profit after tax for 20.22 as it has no impact on the income tax expense for 20.22.

C3. Mark-to-market reserve

Fair value on 1 October 20.21 (200 000 x R6,20) 1 240 000 [½]
Capitalise transaction costs 23 000 [½]
1 263 000
Fair value on 30 September 20.22 (200 000 x R8,45) 1 690 000 [½]
Fair value adjustment 427 000

Tax (R427 000 x 80% x 27%) (92 232) [1]

Mark-to-market reserve (net of tax) 334 768
[2½]

88
C4. Convertible debentures

Present value of the liability

N = 7 years [½]
I = 9% p.a. (market interest rate) [½]
PMT = (100 000 x R10) x 12% = 120 000 [½]
FV = 0 (no cash option) [½]
COMP PV = 603 954
[2]

Financial liability 603 954

Equity component (balancing figure) 196 046 [1]
Proceeds (100 000 x 10 x 80%) 800 000

Interest income for the year ended 30 September 20.22

1 AMORT (interest) R54 356 x 9/12 40 767 [1]
OR
(603 954 x 9%) = 54 356 x 9/12 40 767
[4]

89
CASE STUDY 1 100 marks
YOU HAVE 30 MINUTES READING TIME. SPEND 30 MINUTES READING
THE CASE STUDY BEFORE YOU CONTINUE TO THE REQUIRED
SECTION.

QUESTION 1 58 marks

IGNORE ANY VALUE-ADDED TAX IMPLICATIONS.

CRYPTOCURRENCY

You are a first-year auditing clerk who has been appointed to assist with the audit of Mining Ltd (Mining)
for the year ended 28 February 20.29. For the last few days you have been situated at the head offices
of the company which is in Johannesburg.

Early on the morning of 28 February 20.29, while you were still enjoying a double short latte in your
recyclable Seattle take-away cup, Mr IT Guy came running out of the fish tank (an office partitioned off
with glass) with his laptop held high above him. You could see that his excitement was overflowing, as
he was shouting enthusiastically. All attention was drawn to the thrilled information technology (IT)
specialist and as the realisation dawned through to everyone else in the office, they started to put their
hands together. Slowly at first, but then with eagerness and shouts of congratulations.

An employee sitting across you saw your puzzled face and tried to speak above the noise: “Bitcoin”. “Bit
of what?” you asked confused. “BitCOIN” she repeated herself, this time a bit louder, smiling. “He was
successful in mining another Bitcoin. You know, cryptocurrency”, she explained.

Interesting, you thought to yourself – you were under the impression that mining was in the business
mining of coal only. You soon learnt that the company is mining Bitcoins mainly for the long-term growth
opportunity which potentially lies within this decentralised convertible virtual currency. The coin hit an
all-time high in December 20.27 when it traded at $19 783,21 a coin. It also dropped with more than
50% within 16 days thereafter. Currently it has a value amounting to R55 000 each.

A Bitcoin does not have a unique identification number, but the transaction from which it originates
(named a Satochi, after the founder(s) of Bitcoin) is traceable. However, in order to receive and transfer
bitcoins, or a portion thereof, a Bitcoin Wallet is required. Each Bitcoin Wallet has a unique address.

The Bitcoin Wallet address of Mr IT Guy’s laptop is 18TGt8oGgLzkCpjxMbiRfvbDo9NqMiningg and

within this wallet the balance of the owned Bitcoins is reflected. Mining secures the Bitcoin Wallet by
safeguarding all their computers and the information thereon.

In November 20.23 the first Bitcoin automated teller machine (ATM) opened in a coffee house in
Vancouver, Canada. In May 20.28, South Africa’s first cryptocurrency ATM was installed in
Johannesburg, which made cryptocurrency accessible to individuals who do not have a bank account.

Mining can also exchange its Bitcoins for goods or services.

Considering the above, you commenced your day by writing a very important e-mail to your audit
manager who spent her virtual currency (in the form of air miles) to travel to the Seychelles before the
expiry of the miles. She did however indicate that she could be reached via e-mail for important matters.

90
To: [email protected]
From: [email protected]
RE: Virtual Currency

Mrs Audit Manager,

It came to my attention that our client, Mining Ltd, is also mining virtual currencies - Bitcoin in particular.
The value of the Bitcoins (Bitcoin holdings) that have been mined during the year have not yet been
accounted for in the financial statements of Mining Ltd.

According to the South African Reserve Bank a virtual currency is a digital representation of value that
can be digitally traded and functions as a medium of exchange, a unit of account and/or a store of value,
but does not have legal tender* status.

Further readings on Bitcoin indicated that the potential of Bitcoin is not solely limited to serving as a
payment alternative, it has also been viewed as a commodity, asset class or security ripe for speculative
investment.

Considering the above, I have compiled a list of the possible recognition and measurement of
Mining Ltd’s Bitcoin holdings and will appreciate an indication on the way forward.

The Bitcoin holdings can be recognised and measured either as:

(1) A financial asset; or

(2) An intangible asset.

Hope the air miles rewarded you with fun in the sun.

Regards,
Me
Audit clerk
Audit in Action Inc

* Legal tender is a medium of payment recognised by a legal system to be valid for meeting a financial
obligation. Paper currency and coins are common forms of legal tender in many countries.

DEFERRED TAXATION

After the e-mail was written you returned to assist the accountant with finalising the company’s deferred
taxation calculation. The following incomplete calculation, as well as related information, was supplied
to you: (You may assume that the below information is correct.)

91
 Carrying Tax base Temporary Deferred tax at
amount differences 27%
Notes at 100% or asset/
80% (liability)
R R R R
28 February 20.28
Temporary differences 6 250 000 (1 687 500)
Unused tax loss 8 500 000 (6 250 000) 1 687 500
Deferred tax liability - -

28 February 20.29
Land 1 13 000 000 ?
Buildings 2 a7 200 000 ?
Plant 3 b3 500 000 ?
Inventory 4 1 050 000 ?

Deferred tax

a R3 000 000 x 3 buildings x 20/25 years = R7 200 000

b R7 000 000/7 x 3,5 years = R3 500 000

1. Land

Land is accounted for according to the revaluation method. On 28 February 20.29 the revaluation
surplus account reflects a closing balance of R2 352 000 relating to land only. This amount was
correctly recognised during the current financial year.

2. Buildings

The three buildings are accounted for according to the cost model and depreciated over their
useful lives according to the straight-line method.

On 28 February 20.29 the following journal entry was processed relating to one of the warehouse
buildings after the above schedule was already compiled:

Dr Cr
28 February 20.29 R R
J1 Non-current assets held for sale (SFP) (Balancing) 2 000 000
Accumulated depreciation and impairment (SFP)
(R3 000 000/25 years x 5 years) 600 000
Impairment loss (P/L) (R2 400 000 – R2 000 000) 400 000
Warehouse building at cost (SFP) (given) 3 000 000
Reclassification of warehouse to Non-current assets held for
sale on 28 February 20.29

The South African Revenue Services (SARS) allows a building allowance of 5% per annum, not
apportioned for part of a year, in terms of section 13(1)(b), on these buildings.

3. Plant

Plant was commissioned on 1 September 20.25 at a cost amounting to R7 000 000. The SARS
allows a wear and tear allowance with regard to the plant at 40% of the cost for the first year and
20% for the subsequent three years (not apportioned for part of a year).

92
4. Inventory

Mining valued its inventory at its net realisable value amounting to R1 050 000, which is R150 000
below its cost price. According to section 22(1) of the Income Tax Act, the Commissioner found
that only 20% of the write-down to net realisable value to be just and reasonable to represent the
amount by which the value of such trading stock has diminished.

5. Lease of computers

The lease agreement for the lease of computers contains the following information:

Commencement 1 September 20.28

date
Lease term 3 years
Options contained Options to purchase computers at end of lease term
within the lease
At commencement of lease, there was no indication that the option will be
agreement
exercised
Lease payment R20 000 bi-annually in arrears

The SARS allows a wear and tear allowance over three years on a straight-line method according
to section 11(e) on the cost of computers. Mining depreciates right-of-use assets according to the
straight-line method. On 1 September 20.28 the computers had an expected useful life of three
years.

Mining could not determine the rate implicit in the lease. The incremental borrowing rate of Mining
was as follows:

• 7,75% per annum (compounded bi-annually) at 1 September 20.28; and

• 8,25% per annum (compounded bi-annually) at 28 February 20.29.

At inception of the lease, Mining acquired additional random-access memory (RAM) from
Incredible Connection to enhance the processing power of the computers. The cost of the RAM
amounted to R14 729.

On 28 February 20.29 Mining informed the lessor that they will exercise the option to purchase
the computer equipment at the end of the lease term. The lessor indicated that a final payment
amounting to R40 000 will be payable at the end of the lease term in order to exercise the purchase
option.

6. Bonus

It is company policy to reward deserving employees each financial year with a bonus, which is
payable in the month after the financial year end. For the year ended 28 February 20.28 R95 000
was paid for exceptional performance and in the current financial year that amount totalled
R146 500.

Section 7B of the Income Tax Act deems the expenditure incurred in respect of bonuses to be
incurred by the employer on the date during the tax year on which the amount is paid to the
employee by the employer.

93
7. Leave pay

Employees are granted 28 days of leave during each calendar year. All leave that is not utilised
(taken) during a calendar year, may roll over to the following calendar year for six months only.
There after the leave will be forfeited.

Only personnel who resign will receive a cash payment for any unutilised leave at the date of
resignation. Leave accrues to employees on a pro-rata basis for the number of months of
employment. The following information relates to the leave balances of Mining.

Number of days
Opening balance 1 March 20.28 1 150

Accrued during the year 3 220

Utilised during the year (3 265)
Paid during the year (70)

Closing balance 28 February 20.29 1 035

It is expected that 2 employees will resign in March 20.29. They have each accrued 13 days of
unused leave on 28 February 20.29. The average cost to company per employee per day amounts
to R960, while the average gross salary per employee per day totals R850. Mining remunerates
employees based on their gross salary, when leave is paid out at resignation and accrues leave
based on the cost to the company.

8. Taxation

On 12 February 20.29 an additional assessment was issued for the 20.28 tax year. According to
this assessment R15 000 is payable to the SARS of which R2 500 relates to a penalty for late
payment. Mining did not object this additional assessment.

9. Foreign income

During the current financial year Mining received foreign income which is only taxable in the
country of origin at a rate of 25%. The tax that was paid to the company of origin amounted to
R15 000.

10. Profit before tax

After considering the abovementioned items, the profit before tax for the year ended
28 February 20.29 correctly amounted to R6 000 000.

Additional information

• Assume that the normal income tax rate is 27% and that the capital gain inclusion rate is 80%.
• There are no temporary differences, other than those that are apparent from the information
contained in the question.
• The only non-taxable and non-deductible items included in the accounting profit or loss are those
that are apparent from the information provided.
• Mining expects to realise capital gains in the nearby future.
• You may assume that at inception of the lease contract Mining determined that the contract is a
lease in terms of IFRS 16.9.
• Property, plant and equipment (including computers) are accounted for at the cost model and
depreciated over its useful life according to the straight-line method.

94
QUESTION 2 42 marks

IGNORE ANY VALUE-ADDED TAX IMPLICATIONS.

PART I

Furn Decor Ltd (Furn Decor) is a listed company on the Johannesburg Stock Exchange and deals in the
manufacturing and wholesaling of elegant home furniture. It has been in operation for the past
20 years and built a reputation for being the best when it comes to quality home furniture.

You are the newly appointed financial manager of Furn Decor. The financial director has asked you to
assist with the completion of the financial statements for the year ended 30 September 20.29.

An extract of the following balances was presented to you:

Balance on 1 October 20.28 R

Ordinary share capital 40 000 000

Retained earnings 10 250 000

The profit before tax amounted to R18 475 000 before taking the following information into account:

1. On 1 December 20.28, Furn Decor acquired 500 000 ordinary shares in CAP Ltd (CAP) for R5,50
per share. The fair value of the shares on this date was R2 400 000. Furn Decor paid R20 000 in
transaction costs to acquire these shares. On 28 February 20.29, CAP repurchased 15% of their
shares pro-rata from all the shareholders at its fair value. Transaction costs of R8 000 were paid
by CAP. On 30 April 20.29, CAP issued dividends of R0,80 per share to its existing shareholders.

This is the first time that Furn Decor has purchased equity instruments.

Furn Decor irrevocably elected in terms of IFRS 9.5.7.5 to present subsequent changes in the fair
value of the investment in the mark-to-market reserve.

Furn Decor has a policy of reclassifying previous fair value adjustments to retained earnings upon
derecognition or financial assets designated at fair value through OCI.

The following fair value schedule was made available to you:

Date Fair value

1 October 20.28 R4,80 per share
28 February 20.29 R6,85 per share
30 September 20.29 R8,20 per share

2. On 1 October 20.27, Furn Decor purchased unlisted corporate bonds at its face value (also fair
value) of R5 000 000. The bonds pay interest every four months at a nominal market related
coupon rate of 8% per annum. The bonds will mature on 30 September 20.22 at a premium of
15% of its face value. The bonds are correctly held within a business model where the objective
is achieved both by holding financial assets in order to collect contractual cash flows of principal
and interest as well as to sell the bonds.

95
 The financial director also made the following schedule regarding the credit losses balances and
fair values relating to these bonds available to you:

12 month Lifetime
Credit risk
Financial year ended expected expected Fair value
parameters
credit losses credit losses
30 September 20.28 R24 000 R120 000 Low R5 300 000
30 September 20.29 R30 000 R150 000 High (but not R5 550 000
credit impaired)

3. On 1 April 20.27, Furn Decor obtained a loan from Best Bank in order to finance a lucrative
investment project. The loan was for an amount of R5 000 000 and R785 000 is repayable every
6 months, starting from 30 September 20.27, for the next 4 years. On 1 April 20.29, Furn Decor
decided to renegotiate the terms of the loan payable to maintain its liquidity. The loan was settled
by issuing 60 000 non-redeemable Class A preference shares of Furn Decor with a fair value of
R51 each. Preference dividend payments are at the discretion of Furn Decor.

PART II

You have been appointed as the IFRS consultant for Swiss Ltd (Swiss), a chocolate manufacturer that
is listed on the Johannesburg Stock Exchange. Swiss manufactures different varieties of milk and dark
chocolate and has branches all over South Africa.

Currently, the company is trying to expand its footprint in other African countries.

After extensive market research, it was determined that opening up a new branch in Zambia will assist
Swiss to gain entrance in the African market. In order to finance the expansion, Swiss issued 5 000
debentures with a nominal amount of R11 000 000 at a fair value of R2 000 per debenture on
30 September 20.29. Interest of R165 000 is payable quarterly, in arrears, and the debentures will
mature on 30 September 20.23. Each debenture is convertible at the option of the holder into
20 ordinary shares for every five debentures held. Debentures not converted, will be redeemed at their
nominal amount.

On 30 September 20.29 transaction costs of 800 000 were incurred by Swiss. Any transaction costs
incurred on the issuance would be deductible for tax purposes in the tax year in which these costs are
incurred. A market-related interest rate on 30 September 20.29, for similar debentures without
conversion rights is 11% per annum, paid quarterly in arrears.

Only the following entries have been processed in respect of the issue of these debentures:

Dr Cr
R R
30 September 20.29
Bank (SFP) 11 000 000
Financial Liability: Debentures (SFP) 11 000 000
Transaction costs (P/L) 800 000
Bank (SFP) 800 000

96
CASE STUDY 1
REQUIRED

YOU HAVE 150 MINUTES TO COMPLETE THE CASE STUDY

QUESTION 1

Marks

(a) Prepare the audit work paper as instructed by your audit manager in the e-mail below
which she sent in response to your enquiry:

To: [email protected]
From: [email protected]
RE: Virtual Currency

Dear Me

Thank you for your e-mail, and the information relating to cryptocurrency. With regard
to your query, please refer to my comments below:

It is evident to me that Mining Ltd acquired the Bitcoin holdings mainly for capital
appreciation (investment) purposes, to gain from increases in the market value thereof
and will realise it at fair value when it is sold. Should the company decide to transact
with the Bitcoin holdings in order to obtain other goods or services, the Bitcoin holdings
will also be realised at fair value.

Therefore, in my view, to increase the usefulness of the information provided in the

financial statements, the Bitcoin holdings should be measured at fair value, with any
movement in the fair value thereof recognised in profit or loss, since this will provide
both relevant information to users of the financial statements as well as faithful
representation of the financial performance of Mining Ltd.

While I am on leave, please prepare a work paper containing the following:

(i) Discuss whether the recognition and measurement of the Bitcoin holdings at fair 16
value, with any movement in the fair value thereof recognised in profit or loss,
will be best achieved by accounting for the Bitcoin holdings as a financial asset
or as an intangible asset in terms of the International Financial Reporting
Standards relevant to each option;

Please note:
• Your answer should not refer to the Conceptual Framework.

(ii) Also kindly discuss whether Mining Ltd’s Bitcoin holdings qualifies as an asset in 4
terms of the definition of an asset according to the Conceptual Framework; and

97
 Marks

(iii) If the Conceptual Framework supports the recognition and measurement of the 6
Bitcoin holdings at fair value, with the movement in the fair value thereof
recognised in profit or loss.

Regards,
Audit Manager

Communication skills: logical argument 1

(b) Disclose the taxation note to the financial statements of Mining Ltd for the year ended 30
28 February 20.29 as required by IAS12.79-.80.

Please note:
• Comparative figures are not required
• The movement in temporary differences in the current tax calculation has to be
calculated by using the statement of financial position method.

Communication skills: logical argument 1

Please note
• Round off all amounts to the nearest rand.
• Assume all amounts are material.
• Your answer must comply with International Financial Reporting Standards (IFRS).

QUESTION 2

REQUIRED
Marks

PART I

Prepare the equity and liabilities section of the Statement of Financial Position of 24
Furn Decor Ltd for the year ended 30 September 20.29.

Communication skills: presentation and layout 1

Please note:
• Comparative amounts are required.
• Round off all amounts to the nearest Rand.
• Ignore any tax implications.

PART II

Prepare the correcting journal entries to account for the issue of debentures by Swiss Ltd for 17
the year ended 30 September 20.29.

Please note:
• Include journal entries relating to current and/or deferred taxation.
• Journal narrations are not required.
• Round off all amounts to the nearest Rand.

Please note:
• Your answer must comply with International Financial Reporting Standards (IFRS).

98
CASE STUDY 1
QUESTION 1 – Suggested solution

(a) Working Paper

Client Mining Ltd SFP 2

Preparer ME
Reviewer Mrs Audit Manager
Date 1/03/.19

Recognition and measurement of a Bitcoins

(i) Recognition and measurement options

(1) Financial asset

Recognition

IFRS 9 Financial Instruments allows for financial instruments to be measure at fair value,
with the movement in the fair value thereof to be recognised in profit or loss. However,
in order to account the Bitcoin holdings as a financial asset, the Bitcoin holdings has to meet
the definition of a financial instrument in terms of IAS 32
Financial Instruments: Presentation. (1)
In order for the Bitcoin holdings to meet the definition of a financial instrument as defined in
IAS 32; it has to be a contract that gives rise to a financial asset of one entity and a
financial liability (or equity instrument) of another entity. (1)

However the Bitcoin holdings:

• Is not a financial asset as defined in IAS 32, since:

• It is neither cash, due to the South African Reserve Bank that does not regard
bitcoins as legal tender and it cannot be readily exchanged for goods or services
(IAS 7 Statement of Cash Flows); (1)
• nor cash equivalents since their value is exposed to significant changes in
market value (IAS 7); (1)
• Is, not a contractual right since possession of a Bitcoin does not grant the holder
thereof any contractual right to receive cash or another financial asset; and (1)
• Is not an equity instrument or a contract to be settled in equity instruments. (1)

Therefore the Bitcoin Holdings cannot be recognised as a financial asset. (1)

(2) Intangible asset

In order to account for the Bitcoin holdings as an intangible asset the definition and
recognition requirements should be met (IAS 38.18).

Definition

The Bitcoin has to be an identifiable non-monetary asset without physical substance.

(no mark)

99
Since Bitcoin is a form of digital money (virtual currency), it does not have any physical
substance. (1)

Each Bitcoin Wallet in which the value of the Bitcoin holdings is contained has a unique
address and the Bitcoin holdings can be traded on an exchange or in peer-to-peer
transactions, therefore is identifiable. (1)

Bitcoin is also identifiable as it identified to be separable since Mining Ltd can transfer it
via ATM of exchange it for other goods and services. (1)

Monetary assets are money held and assets to be received in fixed or a determinable
amount of money. The value of the Bitcoin holdings is not fixed or determinable, but
subject to major fluctuations that arise from supply and demand that cannot be predicted.
Therefore, it is not monetary but non-monetary in nature. Also, it does not have legal tender
status under the South African Reserve Bank and therefore will remain
non-monetary. (2)

Mining controls the Bitcoin as it can benefit from its long-term growth and it has
restricted access to the Bitcoin wallet by safeguarding their computers (IAS 38.13). (1)

Recognition

Mining Ltd can benefit economically from long term growth and by exchanging it for other
goods and services. (½)

The cost of the bitcoin can be measured reliably at R55 000. (½)

Conclusion

Considering the above, Mining Ltd can account for its Bitcoin holdings as an intangible
asset. (1)

Measurement

The Bitcoin was not purchased, but mined, therefore the initial measurement at cost will
consist of cost directly attributable in obtaining the Bitcoin (being the cost of leasing the
computer equipment, employee cost as well as the electricity cost). (1)

The Bitcoin holdings will subsequently be measured on either the cost model or the
revaluation model. (1)

Since Bitcoin transactions takes place with sufficient frequency and volume to provide
pricing information on an ongoing basis an observable, active market exists in order to
account for Bitcoin according to the revaluation model. (2)

The Bitcoin holdings has an indefinite useful life and therefore will not be amortised.
(1)

However, all movements, other than decreases greater than previous increases, will be
accounted for in other comprehensive income (OCI) and any realised gain will not be
recycled through profit or loss. Therefore the movement in the fair value of the Bitcoin
holdings will not be reflected in profit or loss. (2)

100
 Conclusion

Since the Bitcoin holdings fail to meet the criteria to be recognised as a financial instrument,
recognition and measurement of the Bitcoin holdings at fair value will be best achieved by
accounting for the Bitcoin holdings as an intangible asset according to the revaluation
method. This will, however, not achieve the recognition of the movement in the fair value of
the Bitcoin holdings in profit or loss. (2)

To ensure that the financial statements will provide relevant information to the users thereof,
Mining Ltd can consider additional disclosure of relevant information.
Total (24)
Maximum (16)

(iii) Classification of a Bitcoin holdings as an asset

According to the revised Conceptual Framework, Mining Ltd will be able to classify its Bitcoin
holdings as an asset, if a past event(s) has led the company to have control over a present right
to the Bitcoin holdings that has the potential to produce economic benefits to Mining Ltd which will
encompass an economic resource for Mining Ltd. (1)

Mining Ltd has obtained its Bitcoin holdings due to the mining thereof which is the past event.
(1)

Mining Ltd also obtained a right that has the potential to produce economic benefits since the
Bitcoin holdings entitles or enables Mining Ltd to receive cash by either selling the coins on an
exchange or redeeming it for cash at an automated teller machine (ATM). It also enables
Mining Ltd to receive another economic resource or extinguish liabilities by transferring the
coins. (2)

Mining Ltd also has control over its Bitcoin holdings since it has the present ability to direct
the use (either sell it on the exchange or exchange it for goods or services) of the coins and to
obtain the economic benefits that may flow from it. Mining Ltd also has the present ability to
prevent other parties from directing the use of the coins and obtaining the economic benefits
that may flow from it, since it is securely stored on Mining Ltd’s computers which is under their
control only. (2)

Conclusion:

According to the revised Conceptual Framework, the Bitcoin holdings can be classified as an
asset. (1)
Total (7)
Maximum (4)

(iv) Support of fair value measurement

The revised Conceptual Framework of 2018 (Conceptual Framework) allows for a measurement
bases which accounts an asset at its current value, which includes the fair value thereof. (1)

The revised Conceptual Framework, does however, also indicate that the enhancing qualitative
characteristics of comparability, understandability and verifiability together with the cost
constraint need to be taken into account to select the measurement basis. Since an active
market exists for Bitcoins, there will be limited cost constraints for Mining Ltd to elect that its
Bitcoin holdings should/can be measured at fair value. (3)

101
 Lastly, the revised Conceptual Framework indicates that since the statement of profit or loss is
the primary source of information about an entity’s financial performance for the period,
all income and expenses should be included in this statement. Only in exceptional
circumstances income or expenses arising form a change in the current value of an asset or
liability will be included in other comprehensive income, should it result in the statement of
profit or loss to provide more relevant information or be a more faithful presentation of the
company’s financial performance for the period; which imply that any movements in the fair
value of Mining Ltd Bitcoin holdings for the period under review should be recognised in profit
and loss. (4)

Conclusion

Therefore, the revised Conceptual Framework supports the recognition and measurement of
Mining Ltd’s Bitcoin holdings at fair value with the movement in the fair value thereof recognised
in profit or loss. (1)
Total (9)
Maximum (6)
Communication skills: logical argument (1)

(b) Tax note to the financial statements of Mining Ltd

MINING LTD

NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.29

12. Income tax expense

20.29
R
Major components of tax expense
SA Normal tax
Current tax 126 022
- Current year [C1] 113 522 (26½)
- Under provision for prior years (R15 000 – R2 500) 12 500 (1)
Deferred tax 896 953
- Movement in temporary differences [C2] (790 547) (½)
- Recognition of unused tax loss not previously recognised
[C3] (607 500) (1)
- Unused tax loss utilised [C3] 2 295 000 (½)
Foreign tax (given) 15 000 (1)
1 037 975
Total (30)
Communication skills: Presentation and layout (1)

102
CALCULATIONS

C1. Current tax calculation

R
Profit before tax 6 000 000 [½]
Non-taxable/Non-deductible items:
- Foreign income not taxable (R15 000/25%) (60 000) [1]
- Impairment below tax base not deductible (250 000 x 20%) 50 000 [1]
- Penalty not deductible 2 500 [½]
Movement in temporary differences (taxable) [C2] 2 927 950 [22½]
Taxable profits before unused tax loss 8 920 450
Unused tax loss of prior year (given) (8 500 000) [1]
Taxable profit for the year 420 450

Tax at 27% 113 522 [½]

[26½]

C2. Deferred tax

Temporary Deferred
Carrying differences tax at 27%
Tax base
amount at 100% or asset/
80% (liability)
R R R R
28 February 20.28
Deferred tax at 100% inclusion
rate 6 250 000 (1 687 500)
Unused tax loss - 8 500 000 (6 250 000) 1 687 500
- -
28 February 20.29
Land @ 100% (cost) 10 000 000 10 000 000 - - [1]
Land @ 80%
(revaluation surplus) a3 000 000 - 2 400 000 (648 000) [2]
Buildings b4 800 000 c4 500 000 300 000 (81 000) [2]
NCAHFS – Building @ 80% d2 000 000 e2 250 000 (200 000) 54 000 [2]
Plant f3 500 000 g- 3 500 000 (945 000) [2]
Right-of-use asset C5132 055 - 132 055 (35 655) [4]
Lease of computers C4(121 405) (121 405) (32 779) [4]
Inventory f1 050 000 h1 170 000 (120 000) 32 400 [2]
Bonus accrual f(146 500) - (146 500) 39 555 [1]
Leave pay accrual i(990 740) j968 640 (22 100) 5 967 [2]
5 722 050 (1 544 953) [22]

Movement in temporary differences through P/L –

excluding unused tax loss
(R5 722 050 – R2 400 000) – R6 250 000) (2 927 950) 790 547 [22½]
Movement in temporary differences through OCI (taxable) 2 400 000 (648 000)
Movement in unused tax loss (R0 – (R6 250 000)) 6 250 000 (1 687 500) [½]
5 722 050 (1 544 953)

103
 a R2 352 000 x 100/[100 - (100 x 27% x 80%)] = R3 000 000 [1]
b R3 000 000 x 2 x 20/25 = R4 800 000 or R7 200 000 x 2/3 [1]
c R3 000 000 x 2 x 5% x 15 = R4 500 000 [1]
d Fair value (given) [½]
e R3 000 000 x 5% x 15 = R2 250 000 or R4 500 000/2 [1]
f Given [½]
g Fully written off for tax purposes [1]
h R1 050 000 + (R150 000 x 80%) = R1 170 000 [1]
i (1 035 days – (13 days x 2)) x R960 + (13 days x 2) x R850) = R990 740 [2]
j 990 740 - 26 days x R850 = R968 640 [½]

C3. Movement in unused tax loss

R
Unused tax loss not previously recognised1 (607 500) [1]
Unused tax loss utilised2 2 295 000 [1]
1 687 500
[2]
1 (R8 500 000 – R6 250 000) x 27% = R607 500
2 R8 500 000 x 27% = R2 295 000

C4. Lease liability

Sharp EL-738 HP 10BII

1. 2ndF MODE (Clear all) 1. 2ndF C (Clear all)

2. 2ndF I/Y 2 ENT (P/Y) 2. 2 2ndF PMT(P/YR) [½]
3. R20 000 PMT 3. R20 000 PMT [½]
4. 7,75% I/Y 4. 7,75% I/YR [½]
5. 6 N 5. 6 N [½]
6. COMP PV  R105 271 6. PV  R105 271

Sharp EL-738 HP 10BII

1. AMRT 2 ENT  2 ENT 1. 1 INPUT 1 2ndF FV(AMORT) [1]

2.  2. = = =
3. BALANCE: R89 350 3. BALANCE: R89 350

Sharp EL-738 HP 10BII

1. 2ndF MODE (Clear all) 1. 2ndF C (Clear all)

2. 2ndF I/Y 2 ENT (P/Y) 2. 2 2ndF PMT(P/YR)
3. R20 000 PMT 3. R20 000 PMT
4. 8,25% I/Y 4. 8,25% I/YR [½]
5. 5 N 5. 5 N [½]
6. R40 000 FV 6. R40 000 FV [½]
7. COMP PV  R121 405 7. PV  R121 405

104
C5. Right-of-use asset
R
Lease liability 105 271 [2]
Indirect costs 14 729 [½]
120 000
Depreciation (R120 000/3 x 6/12) (20 000) [1]
100 000
Reassessment: change in lease liability (R121 405 – R89 350) 32 055 [2½]
132 055

105
QUESTION 2

FURN DECOR LTD

EXTRACT OF STATEMENT OF FINANCIAL POSITION AS AT 30 SEPTEMBER 20.29

20.29 20.28
R R
Equity and liabilities
Equity
Ordinary share capital 40 000 000 40 000 000 (½)
Retained earnings [C2] 28 799 664 10 250 000 (7)
Mark-to-market reserve [C3] 1 428 000 - (5)
Fair value adjustment on debt instruments [C4] C4.2294 747 C4.1(178 856) (4½)
Allowance for credit losses 150 000 24 000 (1)
Non-redeemable Class A preference share capital
(60 000 x 51) 3 060 000 (1)

Non-current liabilities
Long-term borrowings [C5.2] 2 123 292 (4)

Liabilities
Current liabilities
Current portion of long-term borrowings [C5.1] 1 241 514 (1)
(24)
Communication skills: presentation and layout (1)

CALCULATIONS

C1. Retained earnings

R R

Opening balance 10 250 000 [½]

Profit for the year 18 392 914
Given 18 475 000 [½]
Ordinary shares – CAP Ltd
Fair value 2 400 000 [½]
Paid (500 000 x 5,50) (2 750 000) [1]
Day 1 loss on purchase of shares (350 000)
Dividends received = 500 000 x 85% x 0,80 340 000 [1½]
Unlisted corporate bonds
Expected credit losses (150 000 – 24 000) (126 000) [1]
Interest on bonds [C4.1] (4 AMORT 6) INT 534 108 [½]
Loan from Bank
Interest on 30 April 20.29 [C5] 4 input 4 (180 454) [½]
Balance 4 input 4 2 760 260 [½]
Issue of preference shares (60 000 x R51) (3 060 000) [½]
IFRIC 19 – Loss on derecognition of loan payable (299 740)
Transfer from mark-to-market reserve 150 750 [½]
28 793 664
[7½]

106
C3. Mark-to-market reserve

R
Fair value adjustment 28 February 20.29
Paid (2 400 000 + 20 000) 2 420 000 [1]
Fair value (500 000 x 6,85) 3 425 000 [1]
1 005 000
Sale of 15% of shares (1 005 000 x 15%) (transfer to retained earnings) (150 750) [1]
Fair value adjustment 30 September 20.29
500 000 x 85% x (8,20 – 6,85) 573 750 [2]
1 428 000
[5]
OR [5]
Fair value adjustment 28 February 20.29
(500 000 x 15%) = 75 000 x (6,85 – 4,80) 153 750 [2]
Less: capitalised transaction costs (20 000 x 15%) (3 000) [1]
150 750
Fair value adjustment 30 Sep 20.29
(500 000 x 85%) = 425 000 x (8,20 – 4,80) 1 445 000 [1½]
Less: capitalised transaction costs (20 000 x 85%) (17 000) [½]
1 428 000 [5]
Note: If student did not use or perform first calc, award ½ to the second
500 000 if used

C4. Fair value adjustment on debt instrument

C4.1 P/YR = 3 [½]

FV = -5 750 000 (5 000 000 x 1,15) [½]
N = 15 (5 years x 3) [½]
PV = 5 000 000 [½]
PMT = -133 333 [(5 000 000 x 8%)/3] [½]
I = 10,34%

Balance on 30 September 20.28 (3 AMORT 3/1 AMORT 3) 5 121 144 [½]

Fair value (given) 5 300 000 [½]
Opening fair value – 1 October 20.28 178 856

C4.2 Balance on 30 September 20.29 (6 AMORT 6) 5 255 253 [½]

Fair value 5 550 000 [½]
Closing fair value 294 747
[4½]

C5. Long-term loan

P/YR = 2 [½]
PV = -5 000 000 [½]
FV = 0
N = 8 (4 x 2) [1]
PMT = 785 000 [½]
I = 10,73%

Balance on 30 September 20.28 (3 AMORT 3) (balance) 3 364 806 [½]

[3]

107
C5.1 Current portion of long-term loan

Capital of PMT 4 and PMT 5 1 241 514

PMT 4 = 604 546 [½]
PMT 5 = 636 968 [½]
[1]

C5.2 Long-term loan

Long-term portion (3 364 806 – 1 241 514) 2 123 292 [1]

[4½]

PART II

FURN DECOR LTD

JOURNALS FOR THE YEAR ENDED 30 SEPTEMBER 20.29

Dr Cr
R R
J1 Liability component of convertible debenture (SFP) [C2] 1 760 629 (1½)
Bank (SFP) [11 million – (R2 000 x 5 000)] 1 000 000 (1)
Equity component of convertible debentures (SCE) [C1] 760 629 (4)
J2 Liability component of convertible debentures (SCE) [C3] 739 150 (1½)
Equity component of convertible debentures (SFP) [C3] 60 850 (1)
Transaction costs (P/L) 800 000 (1)
J3 Current tax payable (SFP) 216 000 (1½)
Equity component (SCE) [C4] 16 430 (1)
Income tax expense (P/L) [C5] 199 570 (1)
J4 Income tax expense (P/L) 199 570 (1½)
Equity component (SCE) [C6] 205 370 (1½)
Deferred tax liability (SFP) [C6] 404 940 (2½)
(17)

CALCULATIONS

C1. Calculation of debt/equity component

Proceeds (R2 000 x 5 000) 10 000 000 [½]

Liability component
PMT = 165 000 (given) [1]
N = 16 (4 x 4) [½]
FV = 11 000 000 [½]
I = 11% [½]
PV = 9 239 371
Equity component 760 629 [½]
[3½]

C2. 11 000 000 – 9 239 371 1 760 629 [1]

108
C3. Allocation of transaction costs

Liability component: 9 239 371/10 000 000 x 800 000 739 150 [1]
Equity component: 760 629/10 000 000 x 800 000 60 850 [½]
800 000
[1½]

C4. 800 000 x 27% 216 000 [1]

C5. 739 150 x 27% 199 570 [½]

C6. 60 850 x 27% 16 430 [½]

C7. Deferred tax CA TB TD DT

Liability component 118 500 221 210 000 000 1 499 779 (404 940) [½]
1 9 239 371 – 739 150 [1]
2 Proceeds [½]

OR

Carrying amount of liability at 30 September 20.29 (9 239 371 - 739 150) 8 500 221 [1]
Tax base of liability at 30 September 20.29 10 000 000 [½]
Taxable temporary difference 1 499 779

Deferred tax liability (1 499 779 x 27%) 404 940 [½]

Recognise in equity (760 629 [C1] x 27%) (205 370) [1]
Recognise in profit and loss 199 570

109