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- February 18, 2020 at 5:39 pm #562300
This question is a sales and lease back, but in substance not a sale as Setter Store Co retains control of use of the asset. Therefore, it recognises financial liability equal to the proceed received and accounted under IFRS9.

The answer state the liability should then be held at amortised cost, being amortised over 20 years. This would result in other income recognised in SOPL, would be $1.85m each year (37m/20yrs)

My question is why amortised method for financial liability will result in other income being recognised instead of expenses like finance cost?

Thank you.

February 20, 2020 at 8:16 am #562479Please accept my apologies for delay in responding – I needed to do some digging to confirm before responding.

You should ignore the sentence “This would result in other income …” and the following sentence (if it is still there – I don’t have a current edition) “However, the amount recognised in the current year would be $nil ….”. Both these sentences related to previous treatment under IAS 17 and are no longer relevant under IFRS 16.

Sale and leaseback is quite a tricky area – but remember this is an audit exam not an accounting exam. So the issue has been simplified by having the transaction on the last day of the year – so there is no finance cost. To work out finance cost going forward we would need to be told what “rental” Setter is paying for the leaseback.

Let’s keep this simple – say Setter pays “rent” $3m at the end of each year for 20 years – that is actually the loan repayment. If after 20 years $37m has been repaid (presumably), the interest rate implicit in this arrangement is 5.1% (approx – you wouldn’t be expected to calculate in AAA). So in the first year the interest expense/finance cost would be $37m x 5.1% = $1.887m. And at the end of the first year, the liability would be $35.887m (i.e. 37 + 1.887 – 3)

February 20, 2020 at 9:48 am #562485Ok, I get it now. Thank you very much!

For IFRS 9, I knew it’s usually initial recognise at FV then plus interest minus payment to get year end the figure.

May I know rationale behind the calculation? Use the above question as example, is that mean for the 37m loan, it repay some part at each year end (which is 3m). Then at the end of year 20, it will repay the remaining part of 37m (which is the financial liability we have calculated )February 20, 2020 at 10:10 am #562486I found this https://www.compeer.com/Home/Educational-Opportunities/Tools-Calculators/Calculators/Loan-Amortization which is great for illustration:

Enter 37000 in as the loan amount and 20 for payment term

Select “Annual” for payment type

Enter 5.1 for interest rate %

Click “calculate”You’ll see the payment schedule which splits the annual repayment between interest and principal. (Note in the box that the annual payment is $2,994 rather than $3,000 because 5.1% is my approximation.) You will see exactly what is meant by “amortisation” i.e. it is a process of gradually reducing a balance. At the end of the lease/loan period – 20 years – the financial liability has been settled in full – so $0 balance.

February 21, 2020 at 4:40 pm #562647For the question of Francis (12/14),

‘A loan of $60milliom was taken out on 1 August 20X3 to help finance the acquisition. The loan carries an annual interest rate of 6%, with interest payment made annually in arrears. The loan will be repaid in 20 years at a premium of $5million’

The answer shows:

‘An effective interest rate should thus be used to allocate the premium over the 20-year life of the loan. There is a risk that the finance charge is not calculated using the effective rate or that the premium is recognised incorrectly’I don’t get the picture of how to treat the premium. Is it treated as separate financial liability? Or add to the $60m when calculate financial liability c/d

February 21, 2020 at 5:21 pm #562649Please remember to start posts about new questions on new threads.

It is NOT treated separately and it cannot be added to $60m (the amount of the loan received) when it is part of the payment schedule.

It may help to think back to how to calculate IRR. For Setter I worked out the implicit rate by considering:

A receipt now – $37m – DF is 1 – PV is $37

Annual payments in arrears for 20 years – $3m – for PV to be $37 (i.e. for NPV to be $0), the annuity factor for years 1-20 must = $37m/$3m = 12.333

I then looked this up in discount tables.In your new Q, what you have is:

A receipt now – $60m – DF is 1 – PV is $60m

Annual payments in arrears for 20 years – $3.6m per annum (i.e. 6% x $60m)

But then at “T20” you also have a payment of the premium – $5m i.e. the payment at T20 will be $8.6m

The only way to find the IRR when you have cash flows other than an annuity (as above) or perpetuity is to use linear interpolation – remember that?

I have calculated it at 2.36%. So in the first year the finance cost will be $1.416mIf the $5m is ignored (wrongly) the IRR would be calculated as only 1.81% (put it into the calculator I linked to my previous post).

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