QUESTION 2 25 marks (30 minutes)

Mall-Mart Ltd is a group that comprises trading subsidiaries that retail food, clothing and merchandise
throughout South Africa and the United Kingdom. You obtain the following relevant information from
the statement of financial position of Mall-Mart Ltd for the year ended 30 June 2017:

• Trade receivables consist of amounts owing by customers;

• Loans receivables consists of loans to employees;
• Mall-Mart owns investments in various companies’ shares listed on the JSE.
• Inventory includes imported merchandise. A significant portion of the inventory is purchased
from China.
• Debentures detailed below.

On 1 July 2016, Blue Orange Limited offered 500 000 13% debentures of R5 each for issue at a
premium of 3%. Only 80% of the debentures were taken up. These debentures are compulsorily
redeemable.

These debentures are repayable in 3 equal annual instalments over 3 years at a discount of 2%
starting on 30 June 2017.

Interest is paid annually, in arrears, on 30 June, which is also the company’s financial year end.

REQUIRED:

a) Identify, with reasons, which risks Mall-Mart may be exposed to. (10)

b) Calculate the internal rate of return of the debenture issue (show all cashflows). (7)

c) Record the above information in the journal entries of Blue Orange Limited for the years ending
30 June 2017. Narrations are NOT required.
(8)

3
QUESTION 2 (SUGGESTED SOLUTION)

PART B:
a) Cashflow: Marks
1/7/X6 2 060 000 1 (500 000*5*1.03*80%)
30/6/x7 (913 333)
-653 333 1 =(2000000*98%)/3
-260 000 1 ((2 000 000)*13%)
30/6/x8 -826 667
-653 333 1 =(2000000*98%)/3
-173 333 1 ((2 000 000-666667)*13%)
30/6/x9 -740 000
-653 333 1 =(2000000*98%)/3
-86 667 1 ((1333333-666667)*13%)

Internal rate of return = 10.271 0.10271

c) Debit Credit
1/7/x6 Bank 2 060 000 (1) ©
Debentures 2 060 000 (1)©

30/6/x7 Interest on debentures 211 583 (2)

Debenture liability 211 583 (1)

Debenture liability 913 333 (2) ©

Bank 913 333 (1)©

30/6/x8 Interest on debentures 139 506

Debenture liability 139 506

Debenture liability 826 667

Bank 826 667

30/6/x9 Interest on debentures 68 927

Debenture liability 68 927

Debenture liability 740 000

Bank 740 000

Amortisation table:
Year Cashflow Interest Principal Balance
cf0 2 060 000 2 060 000
cf1 -913 333 -211 583 -701 751 1 358 249
cf2 -826 667 -139 506 -687 161 671 088
cf3 -740 000 -68 927 -671 072 16
(diff = rounding)

TOTAL 15 MARKS
4
QUESTION 2 (Suggested solution)

a) Credit risk (1) as they are exposed to monies owed by receivables as well as, loans from
employees (1);

Liquidity risk (1): as they are exposed to long term debt (1)

Currency risk (1) : as they are exposed to the foreign currency (1)

Interest rate risk(1) as they are exposed to interest bearing liabilities (1)

Price risk (1): as they are exposed to equity instruments (1) (10)
marks)

MORE EXPLAINATION IS NEEDED

5
QUESTION 3 19.5 Marks

1 Information
Atlantic Airlines Ltd (AA) is an airline that provides domestic and international flights across the
globe. It has a small treasury department focusing on investing and utilising the company’s funds for
investment purposes. AA has a financial year-end of 30 June and elected to early adopt IFRS 9
Financial Instruments in the 2017 reporting period.

You are the financial manager at AA and you have received the following email from John Smith, a
treasury clerk at AA, in connection with the debentures that were acquired by AA during the 2017
financial year:

To: Financial Manager

From: John Smith (Treasury Clerk)
Subject: Debentures and shares bought during the 2017 financial year
Date: 30 August 2017
Dear Financial Manager

Hope you are well.

1. Debentures

It came under my attention that AA bought some debentures during the 2017 financial
year. From the agreement between AA and the company the debentures were bought
from, I obtained the following information:

AA bought 450 000 debentures in cash for R1 455 882 on 1 July 2016, which equalled
their fair value on this date. These debentures have a nominal value of R1 each and earn
interest of 18% annually payable in arrears. The debentures are redeemable on 30 June
2022 at R5.50 per debenture. Brokerage fees of R5800 were paid by AA on the date of
purchase.

After investigating the company’s business model in connection with investments in

debentures, it came to my attention that AA holds these debentures with the purpose of
collecting interest and capital repayments.

I am not sure how to journalise this transaction in the financial records and need to finish
the trial balance for the 2017 financial year end this week. Could you please provide me
with the necessary journal entries I need to process in connection with these debentures
as I do not have an idea where to start?

2. Redeemable cumulative preference shares

Additionally, on 1 July 2014 AA issued 100 000 redeemable cumulative preference

shares to Pumbaa Ltd 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 30 June 2018 at R1,50 per share.

Regards,
John Smith

6
 Marks
QUESTION 3 – REQUIRED Sub-
Total
total
a) Respond to the email received from John Smith. In your response:

i) Only include the journal entries and supporting calculations

necessary to account for the debentures in the financial 11.5
statements of Atlantic Airlines Ltd for the financial year
ended 30 June 2017. Journal narrations must be included.

ii) Discuss in terms of IAS 32 Presentation of financial

instruments, how Atlantic Airlines Ltd should have 7
accounted for the redeemable preference shares. Only
discuss the identification. Do not include any calculations.

Ignore taxation.

Communication and presentation marks 1

Total 19.5

7
To: John Smith
From Financial Manager
Subject: Debentures and shares bought during the 2017 financial year
Date: November 2017

Dear John

Hope you are well.

1. Debentures
Please see below the required journal entries and supporting calculations as requested.
01 July 2016
Dr. Financial Assets (Debentures) at FV through OCI 1 455
(SOFP) 882 1
1 455
Cr. Bank (SOFP) 882 0.5
Recognition of debentures bought on 1 July 2016

Dr. Financial Assets (Debentures) at FV through OCI 5

(SOFP) 800 1
5
Cr. Bank (SOFP) 800
Capitalisation of transaction costs incurred on 1 July 2016

30 June 2017
81
Dr. Bank (SOFP) 000 1
Dr. Financial Assets (Debentures) at FV through OCI 119
(SOFP) 557 1
200
Cr. Interest received 557 2
Recognition of debentures bought on 1 July 2016
3
 12
Dr. Impairment loss (P/L) 000 1
12
Cr Credit loss allowance (SOFP) 000 1
Recognising the credit loss allowance at initial
recognition
Workings
Students must show their inputs from financial calculator to obtain principle marks
2 475
Future Value (FV)
450000 x 5.50 000 1
1 455 882 + 5 1 461
Present Value (PV)
800 682 1
Number (N)
6 0.5
Interest (i) 13.72% 0.5
81
Payments (PMT)
000

2 Redeemable cumulative preference shares

There are two cash flows related to preferences shares (i.e. the payment of preference dividends and the payment of the principal
amount) are considered separately for classification purposes.

Principal amount
When assessing the substance of the agreement between AA and Pumbaa, it is clear that AA has a contractual obligation to
deliver cash to Pumbaa on 30 June 2018.
1
The preference share agreement contains a mandatory redemption element. 1
The principal amount classifies as a financial
liability. 1

Dividends
There is a contractual obligation to deliver cash on a yearly basis of R8000 (8%) even if management decides not to declare a
dividend. 1

4
 The dividend will accumulate even if the company did not have enough profits to declare and pay a preference dividend.
Therefore, if the dividend is not declared in one year it will be carried forward to the next year. 1
Since the preference shares are redeemable, the accumulated dividend will then be paid at redemption date, 30 June 2018. 1
Therefore, based on the substance of this transaction, AA has a contractual obligation to declare and pay all preference
dividends on or before 30 June 2018. 1
Based on the above, preference dividends are classified as a financial liability. 1

Conclusion
The preference shares are classified as a financial liability in the records of AA. 1

available marks 9
Max 7
Regards,
Financial Manager

Communication skills
- Mark should only be awarded if student gave
narrations 0.5
- Mark should only be awarded if student presented the answer in email format 0.5
-2
19.5

5
QUESTION 2 20 marks

Background

Marrayfield Limited (Marrayfield) is a company that teaches primary school learners mental
mathematics in South Africa. Marrayfield deploys a mental maths teacher to each school on contract.
The mental health syllabus is different from the government syllabus and is an optional subject.
Marrayfield has a 31 August year end.

You have joined the management team of Marrayfield as a trainee accountant and keen to impress
this small company so you can progress quickly to executive levels. You will be assisting the CFO
of the company, who has admitted to being unsure about the implications of IFRS9, IAS32 or any
International Financial Reporting Standard that deals with Financial Instruments.

Marrayfield won a Department of Education government contract to supply one teacher per primary
school in the Eastern Cape Region for the next five years. In addition to the normal growth, this
contract allowed Marrayfield to go to the market and search for investment opportunities. Marrayfield
entered into these transactions:
Information

Transaction 1: Pending, but virtually certain orders for the next five years
When you were chatting to the CFO, he said: “Clearly, the fact that we’ve won the contract to supply
mental maths professionals to South African Schools for the next five years gives us a right to future
cash flows. Surely this is an instrument with which we can make money. Surely that is a Financial
Instrument. The auditors claiming this is not a Financial Instrument. They are wrong!”

Transaction 2: Purchase of Government gilts

On 1 March 2018, Marrayfield purchased government gilts for R270 000, the face value is R300 000
and coupon interest is 8 % per annum payable annually. The gilts are redeemable at face value in 3
years. The company intends to hold the gilts to collect contractual cash flows and the return
constitutes interest and capital. The 12 month expected credit losses were R12 000 and the credit
risk of the gilts has not increased significantly and was unchanged at the end of the year. The
government gilts were not credit impaired on purchase.

Transaction 3: Investment in Preference shares

On 1 September 2017, Marrayfield purchased an entire issue of 44 000 redeemable no par value
preference shares, issued by Lunmin Holdings Limited. The preference share offers a fixed

3
compulsory preference dividend at 10% p.a. on the issue price of R22 each. Dividends are payable
annually on 31 August.

Ignore VAT and other taxes.

Marks
QUESTION 2 – REQUIRED Sub-
Total
total

a) Transaction 1
Briefly discuss whether the agreement to supply mental maths teachers
to Eastern Cape Department of Education gives rise to a financial asset 4
in terms of IFRS 9.
(b) Transaction 2
Prepare Journal entries to record government gilts in the accounting
records of Marrayfield Limited for the year ended 31 August 2018. 10

(c) Transaction 3
Discuss the various classifications that Marrayfield Limited could use
when accounting for its financial asset.
6
Do not discuss measurement
Do not include any calculations

Total 20

4
Transaction 1

Financial asset is a any asset that is cash , an equity

instrument of another entity or a contractual right to receive
cash or contractual right to exchange financial asset or liability
with another entity under conditions that are favourable to the
entity or a contract that will be settled in the entity's own equity
instruments (2)
Marrayfield has a contractual right to receive cash in the
future, as a result of the contract (0.5)
Financial instrument is any contract that gives rise to a
financial asset of one entity and a financial liability(or equity
instrument) of another entity. (0.5)
The contract gives rise to trade receivable for Marrayfield and
Trade payable of Department of Education (1)
4

Transaction 2
01-Mar-
18
PMT 24 000 1
PV -270 000 0.5
N 3 0.5
FV 300 000 0.5
i 12.18
DR CR
Government Gilts SFP 270000 1
Bank 270000 1

Impairment loss
P/L 12 000 1
Credit loss allowance
SFP 12 000 1

30-Jun-
18
Government gilts SFP 10 958 1
interest income 10 958 1
270000*12.18*4/12 1.5
Capitalising 4 months interest to
the FA
10

Transaction 3

a) Discussion of financial assets

There are three possible classification options relevant to the

investment in the preference shares, (being an investment in a debt
instrument):
• Amortised cost; 0.5

3
• Fair value through other comprehensive
income; and 0.5
• Fair value through profit or loss. IFRS
9.5.2.1 0.5
Deciding which classification is appropriate to the investment in the
preference shares will require Marrayfield Limited to assess:
• The objective of the business model used to manage
the financial asset; and 0.5
• The contractual cash flow characteristics of the
financial asset. IFRS 9.4.1.1 0.5
Amortised cost:
To classify the investment in preference shares at
amortised cost, both the following criteria must be satisfied:
• The investment must be held in terms of a business model the objective of which
is to hold it to collect the related contractual cash flows (held to collect); and 0.5
• The investment offers contractual terms that give rise to cash flows that
are solely payments of principal and interest on the principal. IFRS 9.4.1.2 0.5
APPLICATION: In this case, the investment in the preference shares offers
contractual cash flows that constitute solely a return of principal and interest on
that principal(1). This means that if the business model objective is to hold the
investment to collect the contractual cash flows, the investment must be classified
at amortised cost (AC), unless this classification would result in an accounting
mismatch in which case it could be classified at fair value through profit or loss
(FVPL) instead (see below). (1) 2

Fair value through other comprehensive

income:
To classify the investment in the preference shares at fair value
through other comprehensive income, both the following criteria must
be satisfied:
• The investment must be held in terms of a business model the objective of which is to
hold it to collect it contractual cash flows and to sell it (held to collect and sell); and 0.5
• The investment offers contractual terms that give rise to cash flows
that are solely payments of principal and interest on the principal. IFRS 0.5

APPLICATION
In this case, the investment in the preference shares offers contractual cash flows that
constitute solely a return of principal and interest on that principal. This means that if the
business model objective is to hold the investment to collect the contractual cash flows
and to sell the investment, the investment must be classified at fair value through other
comprehensive income – debt (FVOCI-debt), unless this classification would result in an
accounting mismatch in which case it could be classified at fair value through profit or
loss (FVPL) instead (see below). 2
Fair value through profit or loss:
If either the business model test fails (i.e. the asset is held for trading) and/ or the contractual cash
flow test fails (i.e. the asset does not offer contractual cash flows, or the contractual cash flows
offered by the asset do not constitute purely a return of principal plus interest on principal), then the
investment in preference shares must be classified at fair value through profit or loss. IFRS 9.4.1.4 1
Similarly, if the investment met the requirements to be classified at amortised cost or met the
requirements to be classified at fair value through other comprehensive income but these
classifications would have led to an accounting mismatch, then Marrayfield could elect on initial
recognition to classify the investment at fair value through profit or loss instead. This election would
be irrevocable. See IFRS 9.4.1.5 1
APPLICATION

4
In this case, the investment does offer contractual cash flows that represent solely the return of principal plus i
on principal and thus the investment would be classified at fair value through profit or loss if:
• It was held for trading 1

Available 11.5
Max 6