Issued at discount and matures at premium in instalments
Amahle Limited purchases a 10% CU1,000 debenture on 1 January 2011 issued by ANNIKA LIMITED, a company listed on the JSE Limited. The debenture was issued at 95 and matures in two equal annual instalments on 31 December, commencing on 31 December 2012, at 110. Interest is payable on 31 December. The market related interest rate for similar debentures with the same terms as this debenture is 14,1417%. Transaction costs of CU75 were paid in cash in respect of the issue of this debentures by Annika Limited.
The objective of Amahle Limited’s business model is to hold the debenture in order to collect contractual cash flows. The contractual terms of the debenture give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. The asset was at no stage credit impaired. Ignore expected credit losses. Annika Limited did not designate the debenture as measured at fair value through profit or loss. Annika Limited’s reporting date is 31 December.
REQUIRED
- Prepare the general journal entries (cash transactions included) of Annika Limited for the years 1 January 2011 to 31 December 2013 (inclusive) to account for all matters related to the above transaction.
- Prepare the Debenture Liability general ledger account in the books of Annika Limited for the years 1 January 2011 to 31 December 2013 (inclusive), properly closed off.
🇿🇦 Amahle, meaning “the beautiful one”, is a popular Zulu name and is pronounced Ah-MAH-she.
🇿🇦 Annika is an Afrikaans name meaning “grace” and is the Swedish diminutive of Anna. Pronounced AHN-nee-kah.
SOLUTION
(1) General Journal of Annika Limited
|
|
|
DR CU |
CR CU |
| 2011 | |||
| 01/01 | Bank (SFP) | 950,00 | |
| Fair value adjustment (other expenses)(P or L) | 40,00 | ||
| Debenture liability (SFP) | 990,00 | ||
| Debenture initially recognised at fair value |
| 01/01 | Debenture liability (SFP) | 75,00 | |
| Bank (SFP) | 75,00 | ||
| Transaction costs paid |
| 31/12 | Finance cost (P or L) | 165,59 | |
| Debenture liability (SFP) | 165,59 | ||
| CU915,00 x 18,0975% | |||
| Finance cost recognised at the effective interest rate | |||
| 31/12 | Debenture liability (SFP) | 100,00 | |
| Bank (SFP) | 100,00 | ||
| Recognise finance cost paid | |||
| Balance on Debenture liability account: CU915,00 + CU165,59 – CU100,00 = CU980,59 | |||
| 2012 | |||
| 31/12 | Finance cost (P or L) | 177,46 | |
| Debenture liability (SFP) | 177,46 | ||
| CU980,59 x 18,0975% | |||
| Finance cost recognised at the effective interest rate | |||
| 31/12 | Debenture liability (SFP) | 100,00 | |
| Bank (SFP) | 100,00 | ||
| Recognise finance cost paid | |||
| Balance on Debenture liability account: CU980,59 + CU177,46 – CU100,00 = CU1,058,05 | |||
| 31/12 | Debenture liability (SFP) | 550,00 | |
| Bank (SFP) | 550,00 | ||
| Redemption at premium[(CU1,000,00 x 110%)/2 = CU550,00] | |||
| CU1,058,05 – CU550,00 = CU508,05 |
| 2013 | |||
| 31/12 | Finance cost (P or L) | 91,94 | |
| Debenture liability (SFP) | 91,94 | ||
| CU508,05 x 18,0975% | |||
| Finance cost recognised at the effective interest rate | |||
| 31/12 | Debenture liability (SFP) | 50,00 | |
| Bank (SFP) | 50,00 | ||
| Recognise finance cost paid | |||
| Balance on Debenture liability account: CU508,05 + CU91,94 – CU50,00 = CU550 (rounded) | |||
| Debenture liability (SFP) | 550,00 | ||
| Bank (SFP) | 550,00 | ||
| Redemption at premium[(CU1,000 x 110%)/2 = CU550] | |||
| CU550,00 –CU550,00 = R0 |
Calculations
|
Date of cash flow |
Cash flow CU |
|
| 01/01/2011 | (CU950 – CU75 transaction costs) | 875 |
| 31/12/2011 | (CU1,000 x 10%) | (100) |
| 31/12/2012 | (CU1,000 x 10%) | (100) |
| (CU1,000/2) x 110% | (550) | |
| 31/12/2013 | (CU500 x 10%) | (50) |
| (CU1,000/2) x 110% | (550) | |
Calculation of the fair value of the liability on initial recognition
| Cf0 | 0 |
| Cf1 | 100 |
| Cf2 | 100 + 550 = 650 |
| Cf3 | 50 + 550 = 600 |
| I/YR | 14,1417 |
| NPV = ? = | 990 |
Calculation of the effective interest rate as the liability amount initially recognised changes due to transaction costs
The effective interest rate is defined as “the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument to the net carrying amount of the financial asset or financial liability”.
“The calculation includes all fees, transaction costs, and all other premiums or discounts.”
In this example, the net carrying amount is CU990 (fair value) – CU75 (transaction costs) = CU915 (rounded).
| Cf0 | -915 |
| Cf1 | 100 |
| Cf2 | 100 + 550 = 650 |
| Cf3 | 50 + 550 = 600 |
| IRR = ? = | 18,0975% per annum (rounded) |
(2) General ledger of Annika Limited
