In: Accounting
The first financial instrument was a loan. On January 1, the company borrowed 5million on a key shareholder at rate of 3%, at that time when the market rate of interest was 5%. In order to convince the shareholder to lend the money to the company at a rate lower the the market rate of interest, the company agreed that, in 5 years the shareholder would have the option of either accepting full repayment of the debt, or receiving 500,000 shares in the company. The second financial instrument was a compensatory stock option plan that was granted to 10 key management positions for the first time. The company wanted to provide these employees with additional compensation and due to financial constraints could not increase salaries. The plan allowed these management employees to purchase 5,000 options each to purchase shares at $50 each when they were actually worth $100. The options were granted on January 1, 2017 and were exercisable within a two year period. Total compensation was estimated to be $550,000. And the expected period of benefit was one year beginning on the grant date. No other management employees exercised their options during the year but you exercised all of your options on December 31st 2017. The final transaction. The company decided to enter a contract to purchase U.S currency (December 15 2017). The company agreed to buy $7 million in U.S. currency for $7,070,000 (U.S. $1 = Canadian $1.01) from foreign currency inc. using a 90 day forward contract. Any changes to the Canadian dollars will be transferred to the company. On December 31, 2017 the new value was U.S. $1 = Canadian $ 1.02. Assume fair value of contract was 50,000$ at December 31, 2017
Required:
B) determine the carrying amount of each statement of financial portion at near end, December 31, 2017
1. First Financial instrument is the Loan. It is the compound Financial Instrument as shareholder have the option of either accepting full repayment or receiving 5,00,000 shares in the company.
For this, we have to firstly compute the fair value of Liability.
Step-1- compute cash flows and effective interest rate
Year Cash flows E.I.R(5%) present value of cash flow
1 150000 4.329(annuity factor for 5 years) = 649350
2 5million or 5lacs shares 0.783(annuty factor for 5th yr) = 3917630
Fair value of liability = 4566980
Amount of Loan= 50,00,000
Difference ( equity/Reserve) = 433020
Step-2 Loan Amortisation Table
Opening Interest@5% Repayment Balance
4566980 228349 150000 4645329
So, the carrying amount of Loan on 31Dec 2017 is 46,45,329.
2. Second Instrument is Stock Options.
Total No of employees eligible for options= 10
Number of Stock options =5000
Fair Value of Options =$50
Vesting period =2years
In these options, we have to calculate the share based expense for the year to arrive at the closing balance at every year end.
Expense for year 2017= ( No. of employess* Options granted per employee* fair value of option) * No. of vesting years completed/Total vesting period in years
= (10*5000*50) * 1/2 = 12,50,000
The journal entry of this would be debit employee benefit expense with credit to share based payment reserve with same amount.
In the question , it is given that only one employee has exercised all the options on 31 Dec,2017, then SBP reserve will be credited with the exercise price received from that employee and then that SBP reserve shall be used to issue share capital.
3.The company agreed to buy $7 million in U.S. currency for $7,070,000 (U.S. $1 = Canadian $1.01) from foreign currency inc. using a 90 day forward contract.
At the year end 2017, the new value was(U.S. $1 = Canadian $ 1.02) which comes to value $71,40,000. So, this currency rate changes will be transferred to the company. But with forward contract, the company needs to pay only $70,70,000 at the maturity date of this contract to buy the U.S dollars, so it has proved beneficial to the company.
At the year end the fair value of the contact was $ 50000 so the carrying amount at the year end would be (50000*1.02) $51000.