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Hi! Please explain how the investment income have been calculated here. I’m getting super confused . I don’t understand how the bal c/f is $10602 and also the addition of $302. If you can give me some tips to remember when approaching a question like this i would really appreciate it. This question is from the Kaplan Exam Kit, Question. 396
Thank you so much!Q.) The following extract is from the trial balance of Vernon Co at 31 December 20X8:
$’000 $’000
Cost of sales 46,410
Finance costs 4,050
Investment income (note (iii)) 1,520
Operating expenses (note (iii)) 20,640
Revenue (notes (i) and (ii)) 75,350
Tax (note (vi)) 130The following notes are relevant:
(i) Vernon Co made a large sale of goods on 1 July 20X8, which was also the date of delivery. Under the terms of the agreement, Vernon Co will receive payment of $8m on 30 June 20X9. Currently Vernon Co has recorded $4m in revenue and trade receivables. The directors intend to record the remaining $4m revenue in the year ended 31 December 20X9. The costs of this sale have been accounted for correctly in the financial statements for the year ended 31 December 20X8. Vernon Co has a cost of capital of 8% at which an appropriate discount factor would be 0.9259.
(ii) Vernon Co also sold goods to an overseas customer on 1 December 20X8 for 12m Kromits (Kr). They agreed a 60-day payment term. No entries have yet been made to record this sale, although the goods were correctly removed from inventory and expensed in cost of sales. The amount remains unpaid at 31 December 20X8.
Relevant exchange rates are:
1 December 20X8: 6.4 Kr/$
31 December 20X8: 6.0 Kr/$
(iii) Vernon Co acquired $9m 5% bonds at par value on 1 January 20X8. The interest is receivable at 31 December each year. Vernon Co incurred $0.4m broker fees when acquiring the bonds, which has been expensed to operating expenses. These bonds are repayable at a premium so have an effective rate of 8%. Vernon Co has recorded the interest received on 31 December 20X8 in investment income.
Hi,
The bonds were acquired at par at the start of the year for $9m, so we would initially recognise them at the amount paid of $9m. We would then add an additional $0.4m to the $9m to account for the broker fees (DR Bonds CR Bank). We then need to apply the amortised cost method of accounting.
We firstly account for the effective rate of interest at 8% by applying it to the opening balance (8% x $9.4m) to give 752, DR Bonds CR Interest income.
We then look at the cash received at 5% of the par value of the bonds (5% x $9m) to give 450 (DR Bank CR Bonds).
The net adjustment to the bond for these two figures gives the 302 that you mention.
The key when accounting for the financial instrument is to account for the initial recognition (including and broker fees) and then apply the amortised cost method of accounting. This involves applying the effective interest to the outstanding balance and then accounting for the cash based upon the par value and nominal value of the bond.
Thanks
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