- This topic has 6 replies, 2 voices, and was last updated 4 years ago by
.
- Posts
The question states: To help finance the acquisition, Crow Co issued loan stock at par on 31 January 2012, raising cash of $100 million. The loan has a five-year term, and will be repaid at a premium of $20 million. 5% interest is payable annually in arrears. It is Group accounting policy to recognise financial liabilities at amortised cost.
Answer states: Crow Co has issued loan stock for $100 million, representing 18•2% of total assets, therefore this is material to the consolidated financial statements. The loan will be repaid at a significant premium of $20 million, which should be recognised as finance cost over the period of the loan using the amortised cost measurement method according to IFRS 9 Financial Instruments. A risk of misstatement arises if the premium relating to this financial year has not been included in finance costs.
In addition, finance costs could be understated if interest payable has not been accrued. The loan carries 5% interest per annum, and six months should be accrued by the 31 July year end, amounting to $2•5 million. Financial liabilities and finance costs will be understated if this has not been accrued.
1. Could you please explain if premium and effective interest rate is same? I am confused since I know the effective interest rate is spread over the period of the loan.
2. The interest payable is deducted from the opening liability plus effective interest rate, the cash paid (5% in question) is not part of finance cost so how come the answer is saying finance cost will be understated if this is not accrued. In the amortisation schedule we deduct this to obtain closing liability.
The premium is the excess of the loan repayment over the principal amount received. This together with any other interest repayments along the way is all finance cost. Effective interest rate method describes how the finance cost should be recognised in SoPL.
Finance cost means interest calculated under effective interest rate method. 5% interest is not expense in SoPL it is reduction in liability. Liability will be understated if interest calculated at effective interest rate i.e. finance cost is not accrued.
Thank you!
Is the 5% interest in the question the effective interest rate?
The question’s answer stated ‘ finance costs could be understated if interest payable has not been accrued. The loan carries 5% interest per annum, and six months should be accrued by the 31 July year end, amounting to $2•5 million. Financial liabilities and finance costs will be understated if this has not been accrued.’
From my understanding this 5% is the cash we pay every year and this decreases the liability, hence if this is not accounted for liability will be overstated.
I am very confused about the 5% interest exam answer gave.
Per the Q: “5% interest is payable annually in arrears.” – so this is amount PAID – not effective.
The amount that accrues for the year but has not been paid will be added to the liability at the end of the year – this is basic accrual accounting for interest (assumed knowledge of Financial Accounting). If interest is paid annually on 31 January – the anniversary of the loan – 6 months’ interest should be accrued to the year end (31 July). This will paid (along with another 6 months’ interest), the following 31 January.
- The topic ‘IFRS 9 June 2012’ is closed to new replies.