Concordia University

• ACCO 654

• Assurance — Integrated Problem 3 Solution The following solution is a “best” response, demonstrating a level much higher than competent. However, there may be additional acceptable and reasonable points that are not reflected in this response. In addition, candidates are not expected to prepare a response of this level given the time constraints involved and, if applicable, page limits provided. Memo To: Partner From: CPA Subject: Luxury Living Inc. (LLI) 2020 financial statement audit Assessment Opportunity #1 The candidate prepares an analysis of the convertible bond accounting issue. The candidate demonstrates competence in Financial Reporting. CPA Map Competencies: 1.2.4 Analyzes treatment for complex events or transactions (Elective – Level B) Convertible bonds Issue The bonds were recorded as a liability in the amount of $10,000,000, the total proceeds received. However, the bonds have a conversion feature that needs to be accounted for. The issue is how the conversion feature should be treated under IFRS. Handbook and analysis IAS 32 Financial Instruments: Presentation provides guidance on accounting for compound financial instruments which may contain both a liability and equity component. Per IAS 32, paragraph 29: An entity recognizes separately the components of a financial instrument that Assurance — Integrated Problem 3 Solution 2 / 10 (a) creates a financial liability of the entity and (b) grants an option to the holder of the instrument to convert it into an equity instrument of the entity. For example, a bond or similar instrument convertible by the holder into a fixed number of ordinary shares of the entity is a compound financial instrument. From the perspective of the entity, such an instrument comprises two components: a financial liability (a contractual arrangement to deliver cash or another financial asset) and an equity instrument (a call option granting the holder the right, for a specified period of time, to convert it into a fixed number of ordinary shares of the entity). The paragraph above describes the bonds issued by LLI, because it is the holder of the bonds who decides whether or not to exercise the conversion option, and the conversion rate is fixed at 10 ordinary shares per $1,000 bond. Therefore, the bonds are a compound instrument, meaning there is a financial liability and an equity instrument component to the bond. Per IAS 32, paragraph 31: Equity instruments are instruments that evidence a residual interest in the assets of an entity after deducting all of its liabilities. Therefore, when the initial carrying amount of a compound financial instrument is allocated to its equity and liability components, the equity component is assigned the residual amount after deducting from the fair value of the instrument as a whole the amount separately determined for the liability component. Because the equity component will be the residual interest after deducting the amount determined for the liability component from the fair value of the instrument as a whole, we must first calculate the fair value of the bonds without the conversion feature. Similar bonds in the market that do not have the conversion feature are sold to yield 8%, and LLI’s bonds yield 6%. We will calculate the fair value of the bonds by calculating the present value of the bond cash flows, using 8% as the discount rate. Present value of face va