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I think the following, an extract, from Trailer (the link to the question is here: https://www.accaglobal.com/content/dam/acca/global/PDF-students/acca/p2/exampapers/int/P2INT_2013_jun_q.pdf.pdf & answer is here https://www.accaglobal.com/content/dam/acca/global/PDF-students/acca/p2/exampapers/int/p2int_2013_jun_a.pdf.pdf) is the hardest question I’ve ever done in my life:
Trailer has made a loan of $50 million to a charitable organisation for the building of new sporting facilities.The loan was made on 1 June 2012 and is repayable on maturity in three years’ time. Interest is to be charged one year in arrears at 3%, but Trailer assesses that an unsubsidised rate for such a loan would have been 6%. The only accounting entries which have been made for the year ended 31 May 2013 are the cash entries for the loan and interest received which have resulted in a balance of $48·5 million being shown as a financial asset.
So from the above statement one thing is clear that the $48.5 million is INCLUDED in the financial asset overall figure in the year end statement of financial position that is shown above the notes in the question. However, the answer in my kit is going on the line of as if the financial asset was shown as $50 million even at the year end, I’ll reproduce the answer below (well not the whole answer, I’ll produce the answer after all the amortizing and initial discounting to fair value is done). When we amortize the figures, the asset should then be shown as $47.25 million:
Now I really don’t understand these double entries in my revision kit. It seems very confusing for me. Here are they:
The loan is at a discounted interest rate of 3%, which means that Trailer will effectively incur a loss on interest receivable over the life of the loan. The fair value of the instrument will be lower than the amount advanced and should be measured by calculating the present value of all future cash receipts discounted using the ‘unsubsidised’ rate of 6%,which is the market rate for similar interest. The loss is the difference between amount advanced and the fair value. Effective interest income at the market rate of 6% should then be recognised annually in profit or loss and the financial asset should be held at amortised cost in the statement of financial position.
Correcting double entries:
Initial recognition:
DEBIT Profit or loss (retained earnings)
($50m – $45.99m) $4.01m
CREDIT Financial asset $4.01mEffective interest:
DEBIT Financial asset $2.76m
CREDIT Profit or loss (retained earnings) $2.76mThe effective interest income is $2.76 ($ 46 million – the fair value discounted @ start * 6%) = $2.76 million.
And on the the face of the balance sheet the financial asset is shown as:
(320 + 21 + 141 –4.01(W7) + 2.76(W7)Now earlier we said that the question states ” which have resulted in a balance of $48·5 million being shown as a financial asset.” So first please tell me if this is $48.5 million is included in the ultimate 320 million figure for financial assets for Trailer? If it is then that just means that the above double entries are incorrect.
Because you see that we are told that 48.5 is the year end figure so from 50 then 1.5 has already been reduced. So the initial fair value is 46 (there is a loss of 4), we’ve reduced the original amount by 1.5, so in our adjustments, we will reduce the 48.5 by (4-1.5) 2.5 as 1.5 was already deducted, so the loss of 4 actually is just a loss of 2.5 as 1.5 was already taken into account and add 2.76 of effective interest income to get 48.76 so this is the right answer so we just simply need to credit financial asset by (48.76-48.5) by 0.25 to reduce the slight overstatement so why is this not done and the double entries are as they are?
On a separate issue, connected to the above:
Also aren’t we double counting our retained earnings “accounting entries which have been made for the year ended 31 May 2013 are the cash entries for the loan and interest received” as we are told that and still we are doing this:
DEBIT Financial asset $2.76m
CREDIT Profit or loss (retained earnings) $2.76mIf 1.5 was recognized as income and the true (effective value) is 2.76 so why not just credit the I/S with the difference (2.76-1.5) = 1.26 rather than crediting the whole amount as already 1.5 was included prior to this, according to the question. That this would result in a net charge in the P& L OF -4+1.26 = 2.74 but this is not the case, why?
Is it that the 1.5 interest is not recorded in the P&L as we are told “. The only accounting entries which have been made for the year ended 31 May 2013 are the cash entries for the loan and interest received which have resulted in a balance of $48·5 million being shown as
a financial asset.” ONLY THE CASH ENTRIES HAVE BEEN MADE SO DOES THAT MEAN THAT FOR THE INTEREST RECEIVED OF 1.5 ONLY THE CASH PART FOR IT WAS ACCOUNTED FOR & NOTHING WAS ACCOUNTED FOR IN THE P&L?PLEASE NOTE: I THINK I’VE GOT MY ANSWER TO THE FIRST POST as I figured it out while I was typing the stuff. So maybe you could answer this particular post for me only, as I haven’t got the rationale behind this “double counting issue”
yes, this financial asset IS included in the 320
(Your figure of 4.01 is confusing me – in the ACCA “official” answer they show 3.99 and 46.01 where you show 45.99)
A quote from the question says “The only accounting entries which have been made for the year ended 31 May 2013 are the cash entries for the loan and interest received which have resulted in a balance of $48·5 million being shown as a financial asset”
I’ve just this minute read the end of your second post!!!!!! 🙁
” ONLY THE CASH ENTRIES HAVE BEEN MADE SO DOES THAT MEAN THAT FOR THE INTEREST RECEIVED OF 1.5 ONLY THE CASH PART FOR IT WAS ACCOUNTED FOR & NOTHING WAS ACCOUNTED FOR IN THE P&L?”
No!
Working 4 shows “Interest charge (W8) (3·99) Interest credit (W8) 2·76”
The “only entries” mean that we have debited a financial asset with the cash lent out with 50m and credited the same asset with the 1.5 interest received leaving 48.5 as a loan receivable.
In fact we should have debited the financial asset with the discounted value of 50 (+ interest) to get to 46.01 and then taken it from there. Add interest receivable at 6% of which 1.5 is paid and the balance of 2.76 – 1.5 is added to the financial asset so that, come repayment date, the financial asset stands at 50
Does that answer it for you?
I’m so sorry about that second post. Actually, I was just stressed out. I apologize once again.
I get the entries but what I’m not comfortable with is the fact that if the Basic interest ($ 1.5) was recorded as investment income in the P&L before then why do we recognize the full effective income (from amortizing) of 2.76. Already 1.5 is there, we need to recognize 2.76 so why not just recognize the difference (2.76-1.5) which leads to only 1.26 being recognized, so why double count and recognize the full 2.76.
I’ve lost the question again but do I not remember that we effectively ignored the 50 – 1.5 = 48.5?
Did we not, in effect, start again by calculating the present value of the money to be received at a proper rate of interest of 6% and then go from that point.
Now, think of the double entry for the receipt of $1.5m. You appear to think that the double entry was Dr Cash Cr loan interest in the PorL
NO! The entry so far recorded is Dr Cash Cr Loan receivable – hence the receivable has been brought down from $50m by $1.5m to $48.5m
So far, there has been NO interest reflected in the PorL
Is that better for you?
Yes the above is exactly clearing my confusion. I got confused because the examiner used the word “interest received” so I thought there was interest income recorded in the P&L but you I think now my doubts have gone. Thank you for being there.
Just for clarification, the line read ” The only accounting entries which have been made for the year ended 31 May 2013 are the cash entries for the loan and interest received which have resulted in a balance of $48·5 million being shown as a financial asset.”
So yes, careful reading was required to get the correct line of thought, because even though he says “interest received” he then later states “.. which have resulted in a balance of $48.5 million…” so the above makes perfect sense.
Thanks,
G
why do we CR RE $2.76 as i think this is interest paid?
about the revaluation gain on investment property why do we dr RE $30? the $12 has been reversed ( $12/29yrs takin account into depreciation,this is still 1/6/12 so why do we divide it y 29 yearsand not 12/30yrs?) hence this is reversed giving a revaluation gain $21 which goes to oce
thanks
$2.76 is the “correct” amount of interest receivable at a market rate of interest
$90m depreciated for the year to 2012 is $87m
This is revalued to $75 at 2012 by charging PorL with $12m
As at year end 2013, $75 is depreciated by 1/29 down to $72.41 and then revalued upwards to $105.
The revaluation will go to credit PorL but only by an adjusted $12m ($12m – the amount by which last year’s depreciation was reduced by the downwards revaluation). Calculate how much depreciation SHOULD have been charged if no write down had occurred ($3m). How much depreciation in fact WAS charged ($2.59). So the $12m reversal is reduced by that “undercharged” depreciation ie reverse through PorL only $11.59
The remainder of the revaluation to $105m (105 – 72.41 – 11.59 = 21 revaluation) ie $21m will be credited to Revaluation Reserve.
You need to be careful with your dates!
Where an asset is revalued, we need to charge depreciation on the carrying value of that asset brought forward from last year up to the date of revaluation
So, even though we are still at the year end 2012 when we realise that the asset is only worth $75m, we still need to depreciate for a full year the asset at a value of $90m
Depreciate, then revalue
OK?
Here’s an extract from the question:
“On 31 May 2013, the valuer advised Trailer that the offices should now be valued at $105 million. Trailer has charged depreciation for the year but has not taken account of the upward valuation of the offices. Trailer uses the revaluation model and records any valuation change when advised to do so.”
The first line “On 31 May 2013, the valuer advised Trailer…..” combined with the last line ….
“……. records any valuation change when advised to do so.” suggests that Trailer has recorded the valuation increase of 105 – 75. But this is incorrect. So the 30 charge / adjustment to retained earnings is to reverse the 30 credit that presumably went through “when advised”Lower down in the workings for Retained Earnings we see $11.58 being credited and that is the correct entry as I have explained above
OK?
sorry. do we do this adjustment of the current value less the cost i.e 105-75 = 30, and dr RE each time if we get a similar revaluation question or does it depend on what question says as you mentioned the question states Trailer uses the revaluation model and records any valuation change when advised to do so.”. if it doesn’t state that, will we still dr RE ( make adjustment to RE)?
Kerri, it all depends on the question. If the directors have done something wrong, you have two choices.
1) you can reverse their bad entries and then put through the correct entries (looks that this is what the printed solution has done) or
2) see what they HAVE done, work out what they SHOULD HAVE done and put through the entry that gets us from bad entries to good entries.
Personally, I prefer the “Undo their bad entries by reversal and then put through the right ones”
But the choice is yours!
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