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Hi Mike,
could you please explain with a more details need to unwind discount for the amount that persist due to share issue?
This unwind no need to be done when we have share for share exchange, right?
Thank you.
Regards,
“This unwind no need to be done when we have share for share exchange, right?”
Correct. Unwinding discount only applies where there is an element of deferred cash payment within the acquisition cost
The unwinding principles are exactly the same as those that you came across at F2 (or university if you were exempt F2!)
Say we have to pay $100,000 in 3 years’ time and our cost of capital is 10%
The question you need to ask is “How much should I invest TODAY earning compound interest at 10% so that I shall have $100,000 in 3 years’ time?”
The answer is $75,131.48
How did I get there?
I divided $100,000 by 1.10 (that’s 1 + the interest rate expressed as a percentage) and I did that exercise three times (for the 3 years)
That $75,131 represents the TODAY value of the future obligation ($100,000 payable in 3 years’ time)
At the end of the first year after that calculation, the obligation will increase because we are one year closer to having to pay the $100,000
The amount by which it increases is the unrolled discount
10% x $75,131.48 = $7,513.15 and the double entry to record that increase is:
Dr Finance charges (SoPorL)
Cr Obligation account (SoFP)So now the obligation stands at $75,131.48 + $7,513,15 = $82,644.63
Another year goes by and the obligation in payable soon – in fact it’s payable after one more year
So, at the end of the second year we must unroll the discount in the same way we did for year 1
10% x $82,644.63 = $8,264.46 and the double entry to record that increase is:
Dr Finance charges (SoPorL)
Cr Obligation account (SoFP)So now the obligation stands at $82,644.63 + $8,264.46 = $90,909.09
Can you do the last year unrolling?
Hi MIke.
So, for the last year Finance charge will be 100,000-90,909.09 or 10% of 90,909.09 and it’s 9,090.9.
And with time portion situation, for the first year, I will apply time portion from the date of Acq. to the end of year, let’s say 8 months for example, right?
Thank you.
Regards,
That’s correct
Using the values from the example above where the first year’s unwinding finance charge was $7,513.15 … if the period from date of acquisition to the reporting date had been only 8 months then the appropriate finance charge would have been 8/12 x $7,513.15 = $5,008.77
Technically it’s not accurate but it’s the way that is acceptable for the purposes of the ACCA F7 examination because the method necessary to achieve accuracy is far too complicated for the exercise of gaining 1 mark in the F7 exam
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