Financial instruments- Question:Jedders , part C

1 - it's a compound instrument ie part debt and part equity. Calculate the value of the debt, deduct from face value of the instrument and the remainder is equity. Why? That's the way it is! 2 - because the EFFECTIVE interest rate is 10% and that's the TRUE cost of the borrowing. The reason we can get away with just PAYING 7% is that there is an equity element involved within the instrument Ok?

ok, thanks mike

You're welcome

Mike, why is the 1.05 subtracted in arriving at the 278?

Also, in Pingway (June /08) the interest payment in the SOPL is at the higher rate only (as opposed to Jedders (above) which uses the lower plus the higher rate). In these type of questions I am good up to the part of calculating the debt and equity component. After that (show how its accounted for in the SOPL & SOFP) is where I get confused. Please explain.Thanks.

Pingway's finance cost answer just has the liability amt of $8,674,000 x 8%=693,920. It is done just as the example in the BPP text (liability element x higher interest rate). As such I don't understand why in the Jedders answer (1st post but finance cost extract shown in this post also) all that extra working was done. SOPL (EXTRACT FROM JEDDERS) interest paid [7% x 15mil] + 278= 1,328 working= [10% x 13.2795 mil] – 1.05 mil= 278 nb:I should have added this in my previous post , I try to be as detailed and concise as possible in asking my questions. I apologize for the numerous posts but this situation has me very confused since its treated differently in these 2 questions.

"Mike, why is the 1.05 subtracted in arriving at the 278?" "SOPL (EXTRACT FROM JEDDERS) interest paid [7% x 15mil] + 278= 1,328 working= [10% x 13.2795 mil] – 1.05 mil= 278" Let's deal with this one first The "correct" finance cost is 10% of the brought forward liability = 10% x 13,279,500 = an interest cost of 1,327,950 But interest has actually been paid on the face value of the debt at the rate of 7% per annum. 7% x 15,000,000 = 1,050,000 The debt brought forward of $13,279,500 has increased by the "real" rate of interest calculation $1,327,950 to $14,607,450 but interest has been paid amounting to 7% of the face value ($1,050,000) so the debt falls back by this amount to $13,557,450 Pingway official solution, on the very last line... ("The interest cost in the income statement should be $693,920 ($8,674,000 x 8%), requiring an accrual of $393,920 (693·92 – 300 i.e. 10,000 x 3%). This accrual should be added to the carrying value of the debt")... tells you the same as for Jedders. The true interest cost is 8% ($693,920 above) but the amount actually paid is 3% x $10,000 = $300,000 So, take the present value of the obligation $8,674,000, add the true interest of $693,920 and deduct the interest actually paid $300,000. That will leave an obligation to carry forward of $9,067,920 Is that ok or do you need more?

I understand what was done in pingway but i still don't understand why this was done in jedders...."working= [10% x 13.2795 mil] – 1.05 mil= 278? My working for jedders was 10% of the liability, $13,279,500= $1,327,950. If this is rounded off by the thousand, I would get $1,328 which is the same as what the answer has. So I'm wondering if what I did here is correct in arriving at the answer.

It depends up to which point you are taking the calculation. If you are looking for the obligation to carry forward on the statement of financial position, then you need to deduct the interest actually paid. If you are looking to see how much should be the finance charge in the statement of income, you can arrive at that figure without deducting the interest actually paid ok?

ok

Good, and good luck next week