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On 1 January 20X1, Tokyo bought a $100,000 5% bond for $95,000, incurring issue costs of $2,000. Interest is received in arrears. The bond will be redeemed at a premium of $5,960 over nominal value on 31 December 20X3. The effective rate of interest is 8%.
The fair value of the bond was as follows:
31/12/X1 $110,000
31/12/X2 $104,000
Required:
Explain, with calculations, how the bond will have been accounted for over all relevant years if:(c) Tokyo’s business model is to trade bonds in the short-term. Assume that Tokyo sold this bond for its fair value on 1 January 20X2.
sir i want to understand why has this part c) been treated as if the debt was held under FVPL? Isnt short-term trading the criteria set for FVOCI, in case of financial assets held in the form of debt.
The question is very interesting and thank you for putting it up.
The following is my analysis (probably wrong, just an attempt to approach it):
According to the opentuition notes,
A financial asset is measured at amortised cost if it fulfils both of the tests:
1) Business model test: hold till maturity
2) contractual cash flow test: contractual cash receipt for the assetNow here’s the important part:
If the contractual cash flow test is satisfied but there is no intention to hold the asset till maturity; it is held under FVOCI. In other words, if the item satisfied (2) but not (1), it is held under FVOCIOur case in Tokyo’s here is:
The guy bought the bond solely for trading and want to re-selling it asap for some easy money, so it is not satisfying the business model test and at the same time the contractual cash flow test, since he doesn’t buy it and hold it with the purpose to receive both redemption and interest income; it satisfies neither thus may classified under FVTPL.Or second possibility:
maybe there are accounting mismatch if Tokyo’s measure it under FVOCI. Therefore, it is more faithfully representing the substance if Tokyo’s present it under FVTPL.A tutor insight will be much appreciated.
@Kok Yau upon closer inspection of the question and the underlying topic, I think I have figured the reasoning for categorising part c) under FVPL, which is slightly different from your own. Your reasoning makes good deal of sense too, but in any case thought of sharing my own, so here it is:
We categorise financial assets, held as debt instrument under Amortised cost method if we are sure that we will be keeping the asset until redemption(we are clear about that, assuming contractual cash flow test is met). With FVPL our business model is that we will be keeping the debt instrument for trading purposes only, sell it soon enough and book profits. But under FVOCI, we have a leeway. We may keep the asset until redemption(if economic scenario undergoes a wild change or something), but have the liberty to exit quickly too, to book massive profits or losses(if further losses are expected).
Sir we seem to be guessing too much here, please shed some light!
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