Financial assets IFRS 9 Flashcards
Quick refresher what is present value and future value formula?
What is a perpetuity and what is the formula for present value and pv with growth?
an infinite stream of fixed payments received at the end of each period.
What is an annuity?
a stream of fixed payments received at the end of each period.
What is the Present value of an annuity?
This is the formula when you have been given months but if not then you remove n.
What is the present value of an annuity with growth? ( constant growth of cash flow over time)
What is the definition of a Financial instrument according to IFRS 9 which replaces IAS 39 ( as it was too difficult)
Is a contract that give rise to a financial asset of one entity and a financial liability or equity instrument to another entity ( e.g. derivatives instruments, cash instruments, bonds)
We are going to be only looking at accounting for debentures ( bonds ) What is a bond and how is it different to a loan?
A bond is a debt security in which the issuer is obliged to repay the holders the principal and interest ( the coupon) at maturity.
A bond can be traded on open market whereas a loan cannot.
What is the relationship between bond prices and interest rates?
Inverse relationship ( As interest rates increase bond prices fall and when interest rate falls bond prices increase)
So bond price can be equal to value of the bond, can be more or less explain these situations. ( SO price and FV can be different)
If discount rate = coupon rate then the price of the bond = princpal.
If discount rate > coupon rate the the bonds will sell at a discount ( below par)
If discount rate < coupon rate then the bonds will set at a premium( above par)
If discount rate > coupon rate the the bonds will sell at a discount ( below par)
If discount rate < coupon rate then the bonds will set at a premium( above par)
Why is this the case?
Lets say you buy for $10000 bond with coupon on 10%, and interest rates in the market rise to 15%, all new bonds in the market will earn 15% coupon > 10%, hence the 10% on your bond is less attractive, so the only way you sell your bond is if you lower price to adjust for difference in the interest rate.
If interest rate drops to 5%, all new bonds in the market will earn investors less profit, making the 10% interest on your bond more attractive, so your price will adjust up to difference in interest rate as demand increases for your bond.
What is the initial measurement for debentures?
They are initially measured at Fair value ( any proceeds we received) - transaction costs directly attributable to their issue ( investment bank fee)
what is the subsequent measurement of this financial liability? ( or initial)
Measured using amoritsed cost method.
The amortised method states the Carrying amount of bond ( what we put on B/S) = Pv of all future payments at the effective interest rate.
What is the effective interest rate?
Is it the same as coupon rate?
It is like IRR such that what you receive = Pv calculation ( present value of annuity/ present value if zero coupon) ( its the r that solves this equation.
It is not the same as the coupon rate.
Now what is the income statement effect?
it is the effective rate times our carrying amount.
So when looking at accounting for debentures, we want to look at the balance sheet and income statement effects, what are 2 stock and flow equations that we need to know?
Cash payment = NFE?
Cash payment is not equal to financial expense
NFE = r ( effective rate) x CA
Cash payment = FV ( face value) x C.R ( coupon rate
Assume a bond with face value of £1,000 and maturity of three years that is issued on 31.12.2006 for £751.31. The bond pays no coupons (zero coupon bond).
Determine the interest expense in 2006 and 2007 and the carrying amount on 31.12.2007
Do a check on CA at end of 2007?
So we already know coupon rate is below market rate.
n = 3
FV = 1000
C.R = ( NO COUPON RATE, HENCE EXPLAINS WHY THERE IS A BIG DISCOUNT ON BOND).
r = NA
Price = 751.31
Suppose that on 1st January 2006, a company issues a 3-year bond with a face value of £100 and stated interest rate of 6% for £90. Assume that the effective interest is 10% and coupons are payable at the end of each year. Determine the interest expense and the carrying amounts in 2006 and 2007.
When your checking for PV you are looking at what you have to pay till maturity.
Suppose that on 1st January 2006, a company issues a 3-year bond with a face value of £100 and stated interest rate of 6% for £90. In addition, the company incurred £4.5 in issuance costs. Assume that the effective interest rate is 12% and that
coupons are payable at the end of each year.
Determine the interest expense and the carrying amounts in 2006 and 2007.
Do CA checks for each year.
Part 1 = Lets look at the practical application so IlanBio Plc is an agry-tech company whose main business is to
produce plant extracts. They need to expand their greenhouse capacity and are financing the project with debt. In May 15th, 2017 they issued bonds with nominal value of £500,000. The bonds will pay 4.5% coupons semi-annually (2.25% each) for the next five years. Prevailing market interest rates are 5%.
Reflect the effect this bond issuance and coupon payments will have on IlanBio Plc’s balance sheet and income statement for the financial year ending 31/03/2018. Assume that total net operating assets after the bond issuance are £1,000,000 and that
the associated annual operating profits are £100,000.
First of all draw a timeline.
What are we going to look at through the timeline?
And what is n, C.R, FV r NOA and OI?
n = 5 - 10 (as coupon is semi annually)
CR = 4.5(yearly) ( but semi-yearly is 2.25)
FV = 500000
r = 5%
NOA = 1 mil and OI = 100000.
Initial recognition then Coupon payment, in which where will be a cash payment and interest expense.
Then end of year interest payable.
What is the present value of all future payments when we have months?
FV = face value.
( for the second bit its r/n)
for first bit t = cr/n
r = interest rate.
Part 2 Lets look at the practical application so IlanBio Plc is an agry-tech company whose main business is to
produce plant extracts. They need to expand their greenhouse capacity and are financing the project with debt. In May 15th, 2017 they issued bonds with nominal value of £500,000. The bonds will pay 4.5% coupons semi-annually (2.25% each) for the next five years. Prevailing market interest rates are 5%.
Reflect the effect this bond issuance and coupon payments will have on IlanBio Plc’s balance sheet and income statement for the financial year ending 31/03/2018. Assume that total net operating assets after the bond issuance are £1,000,000 and that
the associated annual operating profits are £100,000.
For initial recognition what do we do and how do we recognise on BS?
First of all we are not told the price we paid for the nominal bonds, see we need to find this carrying amount ( the price should be lower than the face value (£500.000).
So the CA must be the PV of all my future payments at the effective interest rate.
( mistake here it isnt CR/n its interest rate/ n for the second bit)
How can we calculate change in NOA using stock and flow equation and change in NFO?
Part 3 Lets look at the practical application so IlanBio Plc is an agry-tech company whose main business is to
produce plant extracts. They need to expand their greenhouse capacity and are financing the project with debt. In May 15th, 2017 they issued bonds with nominal value of £500,000. The bonds will pay 4.5% coupons semi-annually (2.25% each) for the next five years. Prevailing market interest rates are 5%.
Reflect the effect this bond issuance and coupon payments will have on IlanBio Plc’s balance sheet and income statement for the financial year ending 31/03/2018. Assume that total net operating assets after the bond issuance are £1,000,000 and that
the associated annual operating profits are £100,000.
Now we are going to account for the
coupon payment.
Is cash payment = interest payment?
Part 4 Lets look at the practical application so IlanBio Plc is an agry-tech company whose main business is to
produce plant extracts. They need to expand their greenhouse capacity and are financing the project with debt. In May 15th, 2017 they issued bonds with nominal value of £500,000. The bonds will pay 4.5% coupons semi-annually (2.25% each) for the next five years. Prevailing market interest rates are 5%.
Reflect the effect this bond issuance and coupon payments will have on IlanBio Plc’s balance sheet and income statement for the financial year ending 31/03/2018. Assume that total net operating assets after the bond issuance are £1,000,000 and that
the associated annual operating profits are £100,000.
Now we are going to look at end of interest payable do we pay coupon?
Look at the B/S and income statement effects and here add OI
Work out ROCE ( only equity financed)
ROCE ( LEVERAGED)
FLEV
SPREAD
Part 1 Now lets look at the classwork H&L Ivey Pines, create a timeline for the events here.
It was spring 2011, and Patricia Knowles, sole shareholder of H&L Pines (H&L), a national supplier of
evergreen trees to garden supply retailers, had decided to expand H&L’s product offering. She planned to
carry more exotic trees and shrubs to keep up with the changing demands of retailers. The expansion
would require an investment of $650,000 for the land, greenhouse construction, inventory infusion and
working capital requirements. Knowles wanted the new greenhouse to be operational by December 2012
to ensure that new plants would be ready for the spring planting season.
To help finance the expansion, H&L issued 650 five-year bonds with a coupon rate of 6.5 per cent on May
15, 2011. Interest was to be paid semi-annually on November 15 and May 15. On the date of issuance, the
prevailing market interest rate was seven per cent.
Post all opening balances and record all necessary transactions and adjusting entries dealing with the
issuance of bonds and payments of interest for the period April 1, 2011, to March 31, 2012.
What is n, interest rate, coupon and nominal value?
Bond issued, 6 months coupon payment and then end of year interest.
n = 5 x 2 =10
Coupon rate 6.5% ( yearly but its semi annually so 3.25%)
Interest rate = 7%
Nominal value = 650000
Part 2Now lets look at the classwork H&L Ivey Pines, create a timeline for the events here.
It was spring 2011, and Patricia Knowles, sole shareholder of H&L Pines (H&L), a national supplier of
evergreen trees to garden supply retailers, had decided to expand H&L’s product offering. She planned to
carry more exotic trees and shrubs to keep up with the changing demands of retailers. The expansion
would require an investment of $650,000 for the land, greenhouse construction, inventory infusion and
working capital requirements. Knowles wanted the new greenhouse to be operational by December 2012
to ensure that new plants would be ready for the spring planting season.
To help finance the expansion, H&L issued 650 five-year bonds with a coupon rate of 6.5 per cent on May
15, 2011. Interest was to be paid semi-annually on November 15 and May 15. On the date of issuance, the
prevailing market interest rate was seven per cent.
For initial recognition what do we do and how do we recognise on BS?
Post all opening balances and record all necessary transactions and adjusting entries dealing with the
issuance of bonds and payments of interest for the period April 1, 2011, to March 31, 2012.
First of all we are not told the price we paid for the nominal bonds, see we need to find this carrying amount ( the price should be lower than the face value (£650,000).
So the CA must be the PV of all my future payments at the effective interest rate.
Part 3 Now lets look at the classwork H&L Ivey Pines, create a timeline for the events here.
It was spring 2011, and Patricia Knowles, sole shareholder of H&L Pines (H&L), a national supplier of
evergreen trees to garden supply retailers, had decided to expand H&L’s product offering. She planned to
carry more exotic trees and shrubs to keep up with the changing demands of retailers. The expansion
would require an investment of $650,000 for the land, greenhouse construction, inventory infusion and
working capital requirements. Knowles wanted the new greenhouse to be operational by December 2012
to ensure that new plants would be ready for the spring planting season.
To help finance the expansion, H&L issued 650 five-year bonds with a coupon rate of 6.5 per cent on May
15, 2011. Interest was to be paid semi-annually on November 15 and May 15. On the date of issuance, the
prevailing market interest rate was seven per cent. Now we are going to account for the
coupon payment.
Is cash payment = interest payment?
Post all opening balances and record all necessary transactions and adjusting entries dealing with the
issuance of bonds and payments of interest for the period April 1, 2011, to March 31, 2012.
Part 4Now lets look at the classwork H&L Ivey Pines, create a timeline for the events here.
It was spring 2011, and Patricia Knowles, sole shareholder of H&L Pines (H&L), a national supplier of
evergreen trees to garden supply retailers, had decided to expand H&L’s product offering. She planned to
carry more exotic trees and shrubs to keep up with the changing demands of retailers. The expansion
would require an investment of $650,000 for the land, greenhouse construction, inventory infusion and
working capital requirements. Knowles wanted the new greenhouse to be operational by December 2012
to ensure that new plants would be ready for the spring planting season.
To help finance the expansion, H&L issued 650 five-year bonds with a coupon rate of 6.5 per cent on May
15, 2011. Interest was to be paid semi-annually on November 15 and May 15. On the date of issuance, the
prevailing market interest rate was seven per cent.
Now we are going to look at end of interest payable do we pay coupon?
Post all opening balances and record all necessary transactions and adjusting entries dealing with the
issuance of bonds and payments of interest for the period April 1, 2011, to March 31, 2012
We are going to look at the second part of H& L Pines it is difficult so be careful.
Make a timeline for this information.
Coupon rate = 9.5% x1/2( as semi annual)
Market rate = 8% x 1/2 ( as semi annual)
N = 10 years x 2
Nominal value = 400000
Lets look at the first bit of timeline. What first step would we have done but do we have to do it and what do we do? be careful with proportionalities.
REMEMBER CARRYING AMOUNT ALWAYS BEG BECAUSE WE ARE IN THE SAME YEAR.
Originally we would have to calculate the present value of all my payments using PV formula, which we see here should be higher than Nominal value, although we have already gotten this information. to find beg Carrying value.
Carrying value at last fiscal year, = $436,991 then add the bond interest payable at last fiscal year end 12,667 ( makes sense ). Beg NFOt = 449,658.
Now lets look at the coupon 2 months into this different fiscal year.
Now lets look at the 2nd coupon payment 1/12/2011
treat this.
REMEMBER CARRYING AMOUNT ALWAYS BEG BECAUSE WE ARE IN THE SAME YEAR.
Now lets look at the bond recall 29/02/2012 ( HARD ONE) Firstly what things should we work out?
1) Face value being recalled (this tells us how much of the nominal loan be called back)
2) Price of being recalled ( reduce NOA)
3) NFE recall option
4) Coupon recall option
Now lets look at the bond recall 29/02/2012 ( HARD ONE) Firstly what things should we work out?
1) Face value being recalled (this tells us how much of the nominal loan be called back)
2) Price of being recalled ( reduce NOA)
3) NFE recall option
4) Coupon recall option
HINT SO DEAL WITH THIS TO SEE THE INCOME SHEET AND BALANCE SHEET EFFECTS BUT REMEMBER NFE ( IS SHOWS THE GAIN OR LOSS OF RECALL)
REMEMBER CARRYING AMOUNT ALWAYS BEG BECAUSE WE ARE IN THE SAME YEAR.
Finally lets treat the end of year interest payable? ( remember the CA is always beginning because we are in the same year
