Solutions to MS Chapter 6 (Collins & McKeith chapter 7) questions 8-10

(7) Brax plc

(i) The plant & machinery purchased is not a financial asset as it does not
give a right to receive cash or another financial asset. There is however
a contractual obligation on the part of the company to pay for the plant
and machinery. That obligation is a financial liability.

(ii) Ordinary shares are an equity instrument as defined by IAS 32 and

would therefore be included in equity in the balance sheet.

(iii) The accrued electricity is a financial liability as there is a contractual

obligation that will be settled either by the delivery of cash or another
financial asset. The electricity costs are an expense.

(iv) The bank loan is a financial liability. Brax plc will be contractually obliged
to repay this loan which will involve the transfer of cash or another
financial asset. The money received from the bank is a financial asset.

(v) The government grant will be credited to deferred income and released
to the income statement over the life of the plant & machinery. Deferred
income is not a financial liability as there is no obligation to transfer cash
or another financial asset as along as the terms of the grant are complied
with. It arises from the revenue recognition policy of the company.

(8) Emack plc

The purchase of the shares in January 2007 would initially be recorded at cost
plus transaction costs i.e. £1,733,000 (£1,700,000 + £33,000).

At 31 December 2007:

The shares would be carried at fair value i.e. £1,767,000 (570,000 x £3.10)
The increase in carrying value of £34,000 (£1,767,000 - £1,733,000) would be
taken directly to reserves (the “AFS reserve”) and reported through the
statement of recognised income and expense. The AFS reserve is similar in
nature to the revaluation reserve with which you are familiar in accounting for
Non-Current assets like PPE.

At 31 December 2008:

The shares would be carried at fair value i.e. £1,841,100 (570,000 x £3.23).
The increase in carrying value of £74,100 (£1,841,000 - £1,767,000) would be
taken directly to reserves and reported through the statement of recognised
income and expense.

© McGraw-Hill 2009 Financial Accounting and Reporting 1e By Bill Collins and John McKeith
At 31 December 2009:

The shares are sold in March 2009 for £1,795,500 (570,000 x £3.15) which
represents a loss of £45,600 (£1,795,500 - £1,841,100) compared to their
previous carrying value of £1,841,100 at 31 December 2008. This loss would
be reported in the income statement together with the previously recognised
gains of £108,100 (£34,000 + £74,100) giving an overall gain in the income
statement of £62,500 (108,100 - £45,600). The £108,100 gain transferred
from reserves would be reported as a loss in the Statement of Recognised
Income & Expense to avoid double-counting of the amount.

The transaction is a disposal so you need to remove the investment from the
SOFP and also remove the reserve that is included (following the FV
adjustments):

Shares FV Dr Cr
'000 £'000 £'000 £'000
Jan- Dr Investment 570 1733
11 Cr Cash 1733

Dec- Dr Investment 570 £3.10 1767.0 34.0

11 Cr AFS reserve 34.0

Dec- Dr Investment 570 £3.23 1841.1 74.1

12 Cr AFS reserve 74.1

Dr Cash 570 £3.15 1795.5

Cr Investment 1841.1
Dr AFS Reserve (34 + 74.1) 108.1
Cr Gain (108.1 – 45.6) 62.5

© McGraw-Hill 2009 Financial Accounting and Reporting 1e By Bill Collins and John McKeith
(9) Edsant plc

Workings

(i) Loan to supplier

Loans and receivables are measured at amortised cost.

Balance Interest Repayments Amortised
Year b/f at 2.5% Cost
£ £ £ £

2006 450,000 11,250 - 461,250

2007 461,250 11,531 - 472,781
2008 472,781 11,819 - 484,600

(ii) 4% Bonds

The bonds are measured at amortised cost.

Balance Interest Interest Amortised

Year b/f at 4.5% Received Cost
£ £ £ £

2005 4,900,000¹ 220,500 (200,000) 4,920,500

2006 4,920,500 221,422 (200,000) 4,941,922
2007 4,941,922 222,386 (200,000) 4,964,308
2008 4,964,308 223,394 (200,000) 4,987,702

¹ Bonds initially recognised at fair value less transaction costs i.e.

£5,000,000 - £100,000 = £4,900,000.

Income Statement Extract

Year Ended 31 December 2008
£
Finance income from loan 11,819
Finance costs of bonds (223,394)

© McGraw-Hill 2009 Financial Accounting and Reporting 1e By Bill Collins and John McKeith