Deck 12: Accounting for Financial Instruments

Question 1

The most commonly issued equity instrument would be a redeemable preference share.

Answer 1

False

Question 2

Which of the following are examples of primary financial instruments?

A)futures contracts
B)unearned revenue
C)accrued rent
D)unearned revenue and accrued rent

Answer 2

C

Question 3

In differentiating between a financial liability and equity,the report preparer must consider:

A)the existence of a contractual obligation to deliver cash or another financial asset.
B)the consequences of recording a financial liability and the associated impacts on profit.
C)the substance of the agreement over its form.
D)the existence of a contractual obligation to deliver cash or another financial asset and the substance of the agreement over its form.

Answer 3

D

Question 4

The central issue in classifying a financial liability is the existence of a present obligation.

Question 5

In a convertible note,the embedded option to convert the liability into the equity of the issuer has a fair value of zero on initial recognition when the option is out of the money.

Question 6

When initially recognising the liability and equity components of a compound financial instrument,gains and losses arise and must be recognised.

Question 7

Under IFRS 9,an entity is required to recognise a financial asset or liability on its statement of financial position when,and only when,it becomes a party to the contractual provisions of the instrument.

Question 8

Companies may be motivated to enter into a foreign currency swap in order to hedge receivables held in the currency of the loan,the obligations of which they will undertake in the swap.

Question 9

Derivative instruments generally result in a transfer of the underlying primary financial instrument on maturity of the contract.

Question 10

An equity instrument of another entity is classified as a 'financial instrument'.
TRUE

Question 11

Which of the following are examples of derivative financial instruments?

A)deferred tax and future income tax benefits
B)mortgage loans
C)participating, redeemable preference shares
D)share options

Question 12

In a convertible note,IAS 32 Financial Instruments:
Recognition and Measurement requires the holder of such a financial instrument to present the liability component and the equity component separately on the statement of financial position.

Question 13

Financial instruments have recently been developed and used for what purposes?

A)increasing the volatility of primary financial instruments
B)making speculative gains
C)reducing risks
D)making speculative gains and reducing risks

Question 14

For a designated cash flow hedge,IAS 39 Financial Instruments:
Recognition and Measurement requires the gain or loss on the hedging instrument to be transferred initially to equity and subsequently to profit or loss to offset the gains or losses on the hedged item.

Question 15

When offsetting financial assets and liabilities an entity must settle on a net basis.

Question 16

Derivatives are sometimes called 'secondary' financial instruments.

Question 17

Compound instruments contain both a financial liability and equity component but exclude convertible notes.

Question 18

A derivative financial instrument is one which:

A)creates a contractual link between two entities such that the financial asset or equity item of one entity becomes the financial liability of the other entity and there is a transfer of risks and returns.
B)creates rights and obligations that have the effect of transferring one or more of the financial risks inherent in an underlying primary financial instrument, and the value of the contract normally reflects changes in the value of the underlying financial instrument.
C)creates a contractual link between a secondary financial instrument and a primary financial instrument such that there is an ultimate transfer of a financial asset between the contracting parties.
D)creates rights and obligations that have the effect of transferring the financial returns inherent in an underlying primary financial instrument, and the value of the contract normally reflects changes in the value of the underlying financial instrument.

Question 19

A compound financial instrument is one that:

A)transfers the risks of a primary instrument to another entity.
B)effectively contains a financial liability and equity instrument.
C)ultimately requires the exchange of a financial asset for an equity instrument.
D)offers interest terms such that interest is paid on interest.

Question 20

A change in classification of a financial instrument may occur as a result of 'revised probabilities' of,for example,conversion.

Question 21

The structure of futures contracts as they are traded in future markets is best described in which of the following?

A)All parties that trade in futures make a (relatively small) specific deposit before they enter into the contract.The contract is marked to market on a daily basis and gains on the contract are added to the deposit and losses are deducted.When the deposit reaches a minimum level a margin call will be made to require the trader to reinstate the original deposit.
B)The purchaser of the futures contract is given a set price at which they can exercise the futures contract at or up to a specified date.If during that time or up to that date the buyer of the futures contract decides to exercise it, the buyer pays the exercise price and the seller of the contract agrees to deliver the item within a specified period of the exercise date.In the case of financial futures, they are often closed out before delivery is required.
C)All buyers of futures contracts make a specific deposit that is held in trust by the other party to the contract.As the buyer makes gains, these are deducted from the amount of deposit held by the seller.As the seller makes gains on the contract, the buyer is required to increase the deposit to maintain the same percentage value of deposit.At the delivery date on the contract the deposit has already accumulated the gains and losses and all that is required is for the seller to deliver on the contract.In the case of financial futures, they are often closed out before delivery is required.
D)A futures contract contains an agreement to buy and sell a specified item or financial asset or index at a future date and at an agreed price.The parties to the contract are not required to make any financial commitment at the beginning of the contract, hence futures contracts are considered highly levered and risky for speculation purposes.The buyer pays the agreed sum on delivery by the seller or the contract is closed out before the delivery date.

Question 22

Penitent Plc acquired a parcel of 10 000 call options in Remorse Company Plc on 1 May 2014.The price of the options was €0.50 each and they may be exercised any time over the next 3 years.The exercise price is €11.On Penitent Plc's balance date - 30 June 2014 - the company is still holding the options.The market price of the options at that time was €1.20 each and the price of Remorse Company's shares had risen to €19.What are the entries required to record the purchase of the options and the adjusting entry to mark the options to market in Penitent's books?

A) $\begin{array}{l}1 \text { May } 2014\\\begin{array}{|l|l|r|r|}\hline \mathrm{Dr} & \text { Investment in share options } & 110000 & \\\hline \mathrm{Cr} & \text { Cash } & & 110000 \\\hline & & & \\\hline 30 \text { June } 2014 & & \\\hline \mathrm{Dr} & \text { Investment in share options } & 80000 \\\hline \mathrm{Cr} & \text { Profit on share options }&& 80000\\\hline \end{array}\end{array}$
B) $$\begin{array}{l}1 \text { May } 2014\\\begin{array} { | l | l | r | r | } \hline \mathrm { Dr } & \text { Investment in share options } & 5000 & \\\hline \mathrm { Cr } & \text { Cash } & & 5000 \\\hline & & & \\\hline 30 \text { June } 2014 & & \\\hline \mathrm { Dr } & \text { Investment in share options } & 7000& \\\hline \mathrm { Cr } & \text { Profit on share options } & &7000 \\\hline\end{array}\end{array}$$
C) $$\begin{array}{l}1 \text { May } 2014\\\begin{array} { | c | l | c | c | } \hline \text { Dr } & \text { Accounts payable-Remorse Ltd } & 5000 & \\\hline \mathrm { Cr } & \text { Share options } & & 5000 \\\hline\\\hline 30 \text { June } 2014 & & \\\hline \mathrm { Dr } & \text { Cash } & 7000 & \\\hline \mathrm { Cr } & \text { Gain on share options } & &7000 \\\hline\end{array}\end{array}$$
D) $$\begin{array}{l}1 \text { May } 2014\\\begin{array} { | l | l | r | r | } \hline \mathrm { Dr } & \text { Investment in share options } & 5000 & \\\hline \mathrm { Cr } & \text { Cash } & & 5000 \\\hline & & & \\\hline 30 \text { June } 2014 & & \\\hline \mathrm { Dr } & \text { Investment in share options } & 80000 & \\\hline \mathrm { Cr } & \text { Profit on share options } & & 80000 \\\hline\end{array}\end{array}$$

Question 23

The market price of an option is a function of:

A)market expectations regarding the medium term dividend stream expected on the shares underlying the option.Where the exercise price is expected to be greater than the sum of 2 to 3 years' dividends the option will sell at a discount.Where the exercise price is less than 1 year's expected dividend it will sell at a premium.
B)the difference between the market price of the share and the exercise price on the option.The market price of the option will, however, be greater than this difference where the option does not expire for some time.All other things being equal, the greater the time until the option is to be exercised the greater the difference will be between the price of the option and the difference between the exercise price and the share price.
C)the liquidity of the shares underlying the options.Investors in the market are more interested in options over shares that are subsequently easily traded.A measure of the liquidity of a share is the average volume of shares turned over during a period.The higher this measure, the higher the market price of the option.
D)the market price as being closely linked to the exercise price and where it does not vary significantly from that.The only situation in which this ceases to be true is when significant impacts on the whole market shift the prices of many shares down at once (for example, in the case of a major impact to a whole economy such as was experienced in 2007 when the global financial crisis started).

Question 24

Racquet Plc issued £20 million of convertible notes on 1 July 2013.The notes have a life of 6 years and a face value of £20 each.Annual interest of 5% is payable at the end of each year.The notes were issued at their face value and can be converted at any time over their lives.Organisations with a similar risk profile to Racquet Plc have issued debt with similar terms but without the option to convert at the rate of 7%.What are the appropriate accounting entries to record the conversion of the notes to equity on 1 July 2014 (after interest has been paid and recorded)?

A) $\begin{array}{|l|l|r|l|}\hline \mathrm{Dr} & \text { Convertible notes liability } & 18359921 & \\\hline \mathrm{Dr} & \text { Option to comvert notes to equity } & 1906616 & \\\hline \mathrm{Cr} & \text { Share capital } & & 20266537 \\\hline\end{array}$
B) $\begin{array}{|l|l|r|l|}\hline \mathrm{Dr} & \text { Convertible notes liability } & 18093384 & \\\hline \mathrm{Dr} & \text { Option to convert notes to equity } & 1906616 & \\\hline \mathrm{Cr} & \text { Share capital } & & 20000000 \\\hline\end{array}$
C) $\begin{array}{|l|l|r|r|}\hline \mathrm{Dr} & \text { Convertible notes liability } & 18359921 & \\\hline \mathrm{Dr} & \text { Option to convert notes to equity } & 1906616 & \\\hline \mathrm{Cr} & \text { Gain on conversion of options } & & 266537 \\\hline \mathrm{Cr} & \text { Share capital } & & 20000000\\\hline\end{array}$
D) $$\begin{array} { | l | l | l | l | } \hline \text { Dr } & \text { Convertible notes } & 20000000 & \\\hline \mathrm { Cr } & \text { Share capital } & & 20000000 \\\hline\end{array}$$

Question 25

Which of the following statements about a swap instrument is correct?

A)A company may seek to swap a short-term loan for a long-term loan (or vice versa).Another type of swap is where a company swaps a loan denominated in local currency for a foreign currency loan.After the swap agreement has been made, the primary borrower no longer has a commitment to the primary lender.
B)A company may seek to swap a fixed interest loan for a variable rate interest loan (or vice versa).Another type of swap is where a company swaps a loan denominated in local currency for a foreign currency loan.After the swap agreement has been made, the primary borrower still has a commitment to the primary lender should the other party to the swap default on the arrangement.
C)A company may seek to swap a compound interest loan for a simple interest rate loan (or vice versa).Another type of swap is where a company swaps a fixed interest rate loan for a variable interest rate loan (or vice versa).The swap agreement is enforceable by both parties and the risk of default by either party is minimal.
D)A company may seek to swap a short-term loan for a long-term loan (or vice versa).Another type of swap is where a company swaps a portion of its shares for the shares in another company.After the swap agreement has been made, the relationship between the two companies is stronger and can form the basis of an ongoing strategic alliance.

Question 26

A convertible note may be accurately described as:

A)a derivative financial instrument that affords the holder a stream of cash flows and benefits associated with being a shareholder but transfers the risk to the holders of the convertible options.
B)a secondary financial instrument that from the perspective of the issuer contains a contractual obligation to deliver cash and a put option.
C)a simple financial instrument that affords the holder access to a stream of cash flows in the form of either dividends or interest payments.
D)a compound financial instrument that from the perspective of the issuer contains a contractual obligation to deliver cash and a call option.

Question 27

Layton Enterprises and Hewitt Ltd agree to swap their loans.The terms of the loans are: $$\begin{array} { | l | l | } \hline \text { Layton Enterprises } & \text { Hewitt Ltd } \\\hline \text { Term: } 4 \text { years } & \text { Term: } 4 \text { years } \\\hline \text { Amount: } \$ 750000 & \text { Amount: } \$ 750000 \\\hline \text { Fixed interest rate: } 10 \% & \text { Floating: bank bill rate plus } 0.8 \% \\\hline\end{array}$$ Under the swap agreement Layton Enterprises will make floating rate payments to Hewitt Ltd at the bank bill rate plus 0.8% and Hewitt will make fixed rate payments to Layton Enterprises at 12%. Layton Enterprises' alternative to the fixed interest loan was to pay the bank bill rate (a floating rate).Hewitt's alternative was to pay a fixed interest rate of 13.5%.
Is each company better off under the swap agreement than if it had taken up the alternatives offered by the bank?
What is the net difference in the interest rate paid under the swap and the alternative for each company?

A)Layton Enterprises is better off but Hewitt Ltd may not be.Layton pays 2% less but Hewitt Ltd's position will depend on the level of the bank bill rate in each period.
B)Each company is better off.Layton Enterprises pays 1.2% less and Hewitt Ltd pays 1.5% less.
C)Hewitt Ltd is better off but Layton Enterprises may not be.Hewitt Ltd pays 0.2% less and Layton Enterprises' position will depend on the level of the bank bill rate in each period.
D)Each company's position will depend on the level of bank bill rate in each period.In entering the agreement they are anticipating that it will not go over 13.5%.

Question 28

Catchup Company buys a contract in S&P 500 futures,taking a buy position on 1 April 2013 to 'take delivery' on 30 May 2013.A unit contract in S&P 500 futures is priced at the S&P multiplied by $25.On 1 April the S&P is 2950.By 1 May the index has dropped to 2600 and Catchup decides to close out the contract.What is Catchup's gain or loss on the futures contract?

A)gain of €22
B)loss of €8750
C)loss of €350
D)gain of €8750

Question 29

Basket Plc acquired a parcel of 50 000 call options in Snake and Asp Plc on 1 November 2014.The price of the options was £0.40 each and they may be exercised any time prior to 30 June 2016.The exercise price is £30.On Basket Plc's balance date - 30 June 2016 - the company is still holding the options.The market price of the options at that time was £0.39 each and the price of Snake and Asp Pkc shares had risen to £28 having previously fallen to £15.What are the entries required to record the purchase of the options and the likely action of Basket Plc?

A) $$\begin{array}{l}1 \text { November } 2014\\\begin{array} { | l | l | c | c | } \hline \text { Dr } & \text { lnvestment in share options } & 20000 & \\\hline \mathrm { Cr } & \text { Cash } & & 20000 \\\hline & & & \\\hline 30 \text { June } 2016 & & \\\hline & \begin{array} { l } \text { No entry required as shares can be obtained directly at a } \\\text { lower cost. }\end{array} & & \\\hline\end{array}\end{array}$$
B) $$\begin{array}{l}1 \text { November } 2014\\\begin{array} { | c | l | r | r | } \hline \text { Dr } & \text { lnvestment in share options } & 20000 & \\\hline \mathrm { Cr } & \text { Cash } & & 20000 \\\hline & & & \\\hline { 30 \text { June } 2016 } & & \\\hline \mathrm { Dr } & \text { Loss on share options } & 500 & \\\hline \mathrm { Cr } & \text { Investment in share options } & & 500 \\\hline\end{array}\end{array}$$
C) $$\begin{array}{l}1 \text { November } 2014\\\begin{array} { | c | l | c | c | } \hline \text { Dr } & \text { lnvestment in share options } & 150000 & \\\hline \mathrm { Cr } & \text { Cash } & & 150000 \\\hline & & & \\\hline { 30 \text { June } 2016 } & & \\\hline \mathrm { Dr } & \text { Loss on share options } & 10000 & \\\hline \mathrm { Cr } & \text { Investment in share options } & & 10000 \\\hline\end{array}\end{array}$$
D) $$\begin{array}{l}1 \text { November } 2014\\\begin{array} { | c | l | c | c | } \hline \text { Dr } & \text { lnvestment in share options } & 20000 & \\\hline \mathrm { Cr } & \text { Cash } & & 20000 \\\hline & & & \\\hline { 30 \text { June } 2016 } & & \\\hline \mathrm { Dr } & \text { Shares } & 140000 & \\\hline \mathrm { Cr } & \text { Cash } & & 140000 \\\hline\end{array}\end{array}$$

Question 30

A potential downturn in the share market can be overcome by:

A)taking a buy position on a contract for FTSE 100 IDX futures and then closing out the contract if the market begins to rise.
B)taking out a contract FTSE 100 IDX futures and agreeing to a sell position.The contract should be closed out if the market begins to rise.
C)entering into a forward exchange rate contract and specifying a specific date to purchase currency at a set rate.
D)hedging by agreeing to deliver goods at a specific date in the future at a predetermined price.

Question 31

Pigeon Plc holds a well-diversified portfolio of shares with a current market value on 1 May 2014 of £900 000.On this date Pigeon Plc decides to hedge the portfolio by taking a sell position in ten FTSE 100 IDX futures units.The FTSE 100 IDX is 2980 on 1 May 2014.A unit contract in FTSE 100 IDX futures is priced based on FTSE 100 IDX and a price of £25.The futures broker requires a deposit of £1500.On 30 June the FTSE 100 IDX has fallen to 2570 and the value of the company's share portfolio has fallen to $790 000.What is the gain or loss on the futures contract and the net gain or loss after hedging?

A)loss on futures contract £102 500; net gain after hedging £6000
B)gain on futures contract £10 250; net loss after hedging £99 750
C)gain on futures contract £102 500; net loss after hedging £7500
D)gain on futures contract £164; net loss after hedging £109 836

Question 32

An attribute of an equity instrument is that:

A)the holder is entitled to a fixed-rate return.
B)the holder is not entitled to a fixed-rate return.
C)it always confers voting rights upon the holder.
D)it is always issued at par value.

Question 33

IAS 39 stipulates how financial instruments are to be recognised and measured.Specifically these instruments could be:

A)recorded at their fair value with any changes included in the period's profit or loss unless the instrument was acquired as a hedge.
B)recorded at fair value with any changes recorded directly to equity and only transferred to profit when the asset is derecognised.
C)measured and amortised at cost using the effective interest method.
D)all of the given answers.

Question 34

Under the requirements of the IASB Conceptual Framework how would convertible notes be classified in the statement of financial position?

A)They have the essential characteristics of debt and, using the principle of prudence, would be classified as a liability.
B)They would be classified in a separate category between liabilities and equity.
C)They would be classified as either liabilities or equity at any balance date based on the probability at that time that the notes would, or would not, be converted.
D)They have the essential characteristics of shares and, using the principle of substance over form, they would be classified as equity.

Question 35

Partridge Plc holds a well-diversified portfolio of shares with a current market value on 1 April 2014 of €1 million.On this date Partridge Plc decides to hedge the portfolio by taking a sell position in 15 CAC 40 futures units.The French CAC 40 is 3130 on 1 April 2014.A unit contract in CAC 40 futures is priced based on the French CAC 40 and a price of €25.The futures broker requires a deposit of €80 000.On 30 June the French CAC 40 has fallen to 2980 and the value of the company's share portfolio has fallen to €950 000.What are the appropriate journal entries to record these events?

A) $$\begin{array}{l}1 \text { April } 2014\\\begin{array} { | c | l | r | r | } \hline \text { Dr } & \text { Deposit on SPl futures } & 80000 & \\\hline \mathrm { Cr } & \text { Cash at bank } & & 80000 \\\hline & & & \\\hline { 30 \text { June } 2014 } & & \\\hline \text { Dr } & \text { Loss on share portfolio } & 50000 & \\\hline \mathrm { Cr } & \text { Share portfolio } & & 50000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Deposit held by broker } & 56250 & \\\hline \mathrm { Cr } & \text { Gain on futures contract } & & 56250 \\\hline\end{array}\end{array}$$
B) $$\begin{array}{l}1 \text { April } 2014\\\begin{array} { | c | l | r | r | } \hline \text { Dr } & \text { Futures receivable } & 1173750 & \\\hline \text { Dr } & \text { Deposit on SPI futures } & 80000 & \\\hline \mathrm { Cr } & \text { Futures payable } & & 1093750 \\\hline & & & \\\hline { 30 \text { June } 2014 } & & \\\hline \mathrm { Dr } & \text { Loss on share portfolio } & 50000 & \\\hline \mathrm { Cr } & \text { Share portfolio } & & 50000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Futures receivable } & 56250 & \\\hline \mathrm { Cr } & \text { Gain on futures contract } & & 56250 \\\hline\end{array}\end{array}$$
C) $$\begin{array}{l}30 \text { June } 2014\\\begin{array} { | l | l | r | r | } \hline \mathrm { Dr } & \text { Futures receivable } & 56250 & \\\hline \mathrm { Cr } & \text { Gain on futures contract } & & 56250 \\\hline\end{array}\end{array}$$
D) $$\begin{array}{l}1 \text { April } 2014\\\begin{array} { | c | l | r | r | } \hline \text { Dr } & \text { Deposit on SPl futures } & 80000 & \\\hline \mathrm { Cr } & \text { Cash at bank } & & 80000 \\\hline { 30 \text { June } 2014 } & & \\\hline \mathrm { Dr } & \text { Loss on share portfolio } &50000 & \\\hline \mathrm { Cr } & \text { Share portfolio } & &50000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Futures receivable } &56250 & \\ \hline \mathrm { Cr } & \text { Gain on futures contract } & & 56250\\\hline\end{array}\end{array}$$

Question 36

The characteristics of a swap agreement may be best described as:

A)an agreement in which companies agree to exchange their shares as part of a merger or company acquisition arrangement.The swap provides certainty for the shareholders in both companies as to the timing and relative weighting of the shares in the swap.Swaps must be registered with the stock exchange.
B)an agreement in which lenders exchange portfolios of loan receivables in order to better balance their risks.This is an especially important facility for small banks that may face higher risk exposures as a result of concentrating their loan receivables in a small or niche market.
C)an agreement in which borrowers exchange aspects of their respective loan obligations.Two types of swaps that are commonly used are interest rate swaps and foreign currency swaps.Swap agreements are derivative financial instruments.
D)an agreement in which investors agree to swap entitlements to dividends but retain ownership of the underlying share.This allows traders in the market to make contracts that result in high cash dividends as well as high capital returns on shares.

Question 37

The characteristics of a call option are best described as follows:

A)It allows the holder to sell the shares of the specified company at a prespecified (strike or exercise) price.The exercise price remains fixed, but the option can be traded in a market and its value will depend on the value of the underlying share such that an increase in the price of the share will lead to a decrease in the value of the option (and vice versa).The holder usually does not have to exercise the option and would choose not to if the share price were above the exercise price.
B)It allows the holder to buy the shares of the specified company at a prespecified (strike or exercise) price.The exercise price will depend on the value of the underlying share such that an increase in the price of the share will lead to an increase in the exercise price (and vice versa).The holder is committed to exercise the option or close out the contract by taking a put option position in the market.
C)It allows the holder to buy the shares of the specified company at a prespecified (strike or exercise) price.The exercise price remains fixed, but the option can be traded in a market and its value will depend on the value of the underlying share such that an increase in the price of the share will lead to an increase in the value of the option (and vice versa).The holder usually does not have to exercise the option and would choose not to if the share price fell below the exercise price.
D)It allows the holder to sell the shares of the specified company at a prespecified (strike or exercise) price.The exercise price remains fixed, but the option can be traded in a market and its value will depend on the value of the underlying share such that an increase in the price of the share will lead to an increase in the value of the option (and vice versa).While the holder of a put option usually does not have to exercise the option and would choose not to if the share price fell below the exercise price, the holder of a call option must either complete the contract or close it out by taking out a put option for the same number of shares in the market.

Question 38

What is the appropriate accounting treatment for a loan that is the subject of a swap agreement?

A)Since the loan has been swapped with another, the two loans should be set-off in accordance with IAS 32.
B)The original loan should be removed from the statement of financial position and replaced by the other loan in the swap.
C)The original loan should be removed from the statement of financial position and replaced by the other loan in the swap.In the case of a foreign currency swap this treatment is also appropriate but the gain or loss on foreign currency translation should be deferred and amortised over the life of the loan.
D)The original loan, for which the entity has the primary obligation, should be retained in the statement of financial position.

Question 39

Partridge Plc holds a well-diversified portfolio of shares with a current market value on 1 April 2014 of €1 million.On this date Partridge Plc decides to hedge the portfolio by taking a sell position in 15 Amsterdam IDX futures units.The Amsterdam Index is 3130 on 1 April 2014.A unit contract in Amsterdam IDX futures is priced based on the Amsterdam Index and a price of €25.The futures broker requires a deposit of €80 000.On 30 June the Amsterdam Index has fallen to 2980 and the value of the company's share portfolio has fallen to €950 000.On 1 July 2014 Partridge Ltd decides to sell its shares and close out its futures contract.At this date the portfolio has a market value of €925 000 and the Amsterdam Index is 2900.Assume all entries have been made mark to market on the futures contract and record changes in the deposit up to 1 July.What are the entries to record the transactions of 1 July 2014 (only)?

A) $$\begin{array} { | l | l | r | r | } \hline \text { Dr } & \text { Cash } & 925000 & \\\hline \mathrm { Cr } & \text { Share portfolio } & & 925000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Deposit held by broker } & 30000 & \\\hline \mathrm { Cr } & \text { Gain on futures contract } & & 30000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Cash at bank } & 166250 & \\\hline \mathrm { Cr } & \text { Deposit held by broker } & & 166250 \\\hline & & & \\\hline \mathrm { Dr } & \text { Futures payable } & 1340000 & \\\hline \mathrm { Cr } & \text { Gain on futures contract } & & 166250 \\\hline \mathrm { Cr } & \text { Futures receivable } & & 1173750 \\\hline\end{array}$$
B) $$\begin{array} { | l | l | r | r | } \hline \text { Dr } & \text { Cash } & 925000 & \\\hline \text { Dr } & \text { Loss on share portfolio } & 75000 & \\\hline \mathrm { Cr } & \text { Share portfolio } & & 1000000 \\\hline & & & \\\hline \text { Dr } & \text { Deposit on futures contract } & 30000 & \\\hline \mathrm { Cr } & \text { Gain on futures contract } & & 30000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Cash at bank } & 166250 & \\\hline \mathrm { Cr } & \text { Deposit on futures contract } & & 166250 \\\hline\end{array}$$
C) $$\begin{array} { | l | l | r | l | } \hline \text { Dr } & \text { Cash } & 925000 & \\\hline \text { Dr } & \text { Loss on share portfolio } & 25000 & \\\hline \mathrm { Cr } & \text { Share portfolio } & & 950000 \\\hline & & & \\\hline \text { Dr } & \text { Deposit held by broker } & 30000 & \\\hline \mathrm { Cr } & \text { Gains on futures contract } & & 30000 \\\hline & & & \\\hline \text { Dr } & \text { Cash at bank } & 166250 & \\\hline \mathrm { Cr } & \text { Deposit held by broker } & & 166250 \\\hline\end{array}$$
D) $$\begin{array} { | l | l | r | r | } \hline \text { Dr } & \text { Cash } & 925000 & \\\hline \mathrm { Dr } & \text { Loss on share portfolio } & 75000 & \\\hline \mathrm { Cr } & \text { Share portfolio } & & 1000000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Deposit held by broker } & 30000 & \\\hline \mathrm { Cr } & \text { Cash at bank } & & 30000 \\\hline & & & \\\hline \mathrm { Dr } & \text { Futures payable } & 1340000 & \\\hline \mathrm { Cr } & \text { Deposit on futures contract } & & 166250 \\\hline \mathrm { Cr } & \text { Futures receivable } & & 1173750 \\\hline\end{array}$$

Question 40

Sampras Plc issued £20 million of convertible notes on 1 July 2013.The notes have a life of 6 years and a face value of £20 each.Annual interest of 5% is payable at the end of each year.The notes were issued at their face value and can be converted at any time over their lives.Organisations with a similar risk profile to Sampras Plc have issued debt with similar terms but without the option to convert at the rate of 7%.What are the appropriate accounting entries to record the issue of the convertible notes and the first payment of interest in accordance with guidance provided in IAS 32?

A) $$\begin{array}{l}1 \text { July } 2013\\\begin{array} { | c | l | c | c | } \hline \text { Dr } & \text { Cash at bank } & 20000000 & \\\hline \mathrm { Cr } & \text { Convertible notes } & & 20000000 \\\hline & & & \\\hline { \text { June } 2014 } & & \\\hline \mathrm { Dr } & \text { Interest expense } & 1000000 & \\\hline \mathrm { Cr } & \text { Cash at bank } & & 1000000 \\\hline\end{array}\end{array}$$
B) $$\begin{array}{l}1 \text { July } 2013\\\begin{array} { | c | l | r | r | } \hline \mathrm { Dr } & \text { Cash at bank } & 20000000 & \\\hline \mathrm { Cr } & \text { Convertible notes liability } & & 18093384 \\\hline \mathrm { Cr } & \text { Option to convert notes to equity } & & 1906616 \\\hline & & & \\\hline 30 \text { June } 2014 & & \\\hline \mathrm { Dr } & \text { lnterest expense } & 1266537 & \\\hline \mathrm { Cr } & \text { Cash at bank } & & 1000000 \\\hline \mathrm { Cr } & \text { Convertible notes liability } & & 266537 \\\hline\end{array}\end{array}$$
C) $$\begin{array}{l}1 \text { July } 2013\\\begin{array} { | c | l | r | r | } \hline \mathrm { Dr } & \text { Cash at bank } & 20000000 & \\\hline \mathrm { Cr } & \text { Option to convert notes to equity } & & 18093384 \\\hline \mathrm { Cr } & \text { Convertible notes liability } & & 1906616 \\\hline & & & \\\hline 30 \text { June } 2014 & & & \\\hline \mathrm { Dr } & \text { lnterest expense } & 1266537 & \\\hline \mathrm { Cr } & \text { Cash at bank } & & 1000000 \\\hline \mathrm { Cr } & \text { Option to convert notes to equity } & & 266537 \\\hline\end{array}\end{array}$$
D) $$\begin{array}{l}1 \text { July } 2013\\\begin{array} { | c | l | r | r | } \hline \text { Dr } & \text { Cash at bank } & 20000000 & \\\hline \mathrm { Dr } & \text { Option to convert notes to equity } & 2030277 & \\\hline \mathrm { Cr } & \text { Convertible notes liability } & & 22030277 \\\hline & & & \\\hline 30 \text { June } 2014 & & \\\hline \mathrm { Dr } & \text { lnterest expense } & 1542119 & \\\hline \mathrm { Cr } & \text { Cash at bank } & & 1000000 \\\hline \mathrm { Cr } & \text { Convertible notes liability } & & 542119 \\\hline\end{array}\end{array}$$

Question 41

A preference share is a financial liability:

A)if it provides for mandatory redemption by the issuer for a fixed or determinable amount at a fixed or determinable future date.
B)if it gives the holder the right to require the issuer to redeem the instrument at or after a particular date for a fixed or determinable amount.
C)if it gives the issuer the sole discretion to redeem the instrument at a date of their choice for a fixed or determinable amount.
D)if it provides for mandatory redemption by the issuer for a fixed or determinable amount at a fixed or determinable future date and if it gives the holder the right to require the issuer to redeem the instrument at or after a particular date for a fixed or determinable amount.

Question 42

Which of the following ratios are used as an indicator of the inherent risk in investing in an entity?

A)quick
B)current
C)leverage
D)gross profit

Question 43

Which of the following statements is true about a share option:

A)The nature of the holder's right in relation to the option is affected by the likelihood that the option will be exercised.
B)The nature of the holder's obligations in relation to the option are affected by the likelihood that the option will be exercised.
C)The likelihood of the option being exercised does not affect its classification as a financial liability.
D)The likelihood of the option being exercised does affect its classification as a financial liability.

Question 44

If an entity issued a convertible note at a price of £40.00 and it was determined that a debt instrument of similar risk and rate of interest of 10%-but without the option to convert to equity-could be sold for £32.00,what would be the liability component of the convertible note?

A)£40.00
B)£32.00
C)£44.00
D)£36.00

Question 45

The carrying amount of a financial 'held-to-maturity' asset,subject to an impairment loss:

A)can be reduced through an allowance account.
B)can be reduced through a provision account.
C)must be reduced through an allowance account.
D)must be reduced directly.

Question 46

The classification of a preference share as an equity instrument or financial liability is:

A)affected by a history of making distributions.
B)affected by an intention to make distributions in the future.
C)not affected by a history of making distributions.
D)not affected by the other rights that attach to them if they are non-redeemable.

Question 47

The following journal entry pertains to convertible notes with a face value of €10 million: $\begin{array}{|l|l|r|r|}\hline \mathrm{Dr} & \text { Convertible notes liability } & 9814806 & \\\hline \mathrm{Dr} & \text { Convertible notes (equity component) } & 662432 & \\\hline \mathrm{Cr} & \text { Share capital } & & 10477238\\\hline\end{array}$ Which of the following statements are correct?

A)The instrument was over-valued when it was initially recognised.
B)The convertible note has been converted.
C)The value of the option to convert has increased over the period from initial recognition to conversion, by €477 238.
D)The instrument was over-valued when it was initially recognised and the value of the option to convert has increased over the period from initial recognition to conversion, by €477 238.

Question 48

Which of the following items is not a financial instrument?

A)cash
B)derivative instrument that is unfavourable to the entity
C)goodwill
D)trade accounts receivable

Question 49

Financial assets do not include:

A)cash.
B)notes receivable.
C)an equity instrument of another entity.
D)inventories.

Question 50

Documentation that constitutes a financial instrument as a hedging instrument must include:

A)how the entity will assess the effectiveness of the hedging instrument.
B)the nature of the risk being hedged.
C)the risk management objective and strategy.
D)all of the given answers.

Question 51

David Plc acquired a parcel of 50 000 call options in Goliath Plc on 1 November 2012.The price of the options was €1.50 each and they may be exercised any time prior to 30 June 2015 at exercise price of €30.On the same date the market price for Goliath Ltd shares is €25.On David Plc's reporting period date - 30 June 2013 - the company is still holding the options.The market price of the options at that time was €1.80 each and the share price is €27. What is the financial effect of the above transactions on David Ltd's statement of comprehensive income for the year ending 30 June 2013?

A)Increase by €15 000
B)Decrease by €15 000
C)Increase by €100 000
D)Decrease by €100 000

Question 52

Prepayments are:

A)not financial instruments because they typically provide a right to future goods or services.
B)financial instruments because they typically provide a right to future goods or services.
C)not financial instruments because they typically provide a right to cash or another financial instrument.
D)financial instruments because they typically provide a right to future goods or services

Question 53

In disclosing information about how a financial asset or financial liability meets the conditions to be classified as 'at fair value through profit and loss',an entity must have a narrative description of how this designation is consistent with:

A)industry practice.
B)its own documented investment strategy.
C)The Chartered Institute of Securities and Investments CISI requirements.
D)the law.

Question 54

Which of the following financial instruments can underlie an option contract?

A)interest bearing instruments
B)financial assets
C)shares in other entities
D)all of the given answers

Question 55

The amortised cost of a financial asset or financial liability is the amount at which the asset or liability is measured at initial recognition:

A)minus principal repayments.
B)plus or minus the cumulative amortisation using the effective interest method of any difference between that initial amount and the maturity amount.
C)minus any reduction for impairment.
D)All of the given answers are correct.

Question 56

The risks arising from financial instruments are typically:

A)credit risk, fair value risk and market risk.
B)credit risk, liquidity risk and financial risk.
C)inherent risk, liquidity risk and market risk.
D)credit risk, liquidity risk and market risk.

Question 57

Identify which of the following financial instruments are required under IAS 39 Financial Instruments: Recognition and Measurement to be measured at fair value through profit and loss: $\begin{array}{|l|l|}\hline \text { I } & \text { Loans receivable } \\\hline \text { II } & \text { Shares held for trading } \\\hline \text { III } & \text { Loans payable } \\\hline \text { IV } & \text { Favourable derivative instruments } \\\hline \text { V } & \text { Unfavourable derivative instruments } \\\hline\end{array}$

A)I, II and III
B)I, II and IV
C)II, III and IV
D)II, IV and V

Question 58

Under IAS 23,interest incurred on a financial instrument,is able to be capitalised as part of a qualifying asset.When this is done:

A)interest is never expensed.
B)interest will be expensed as part of cost of goods sold when the asset is sold.
C)interest will be expensed as part of the accounts payable balance.
D)interest is recognised immediately.

Question 59

The exercise price of an option:

A)varies with changes in the market price of an underlying share
B)remains fixed for the duration of the option.
C)is always at a price below market price when issued.
D)All of the given answers are correct.

Question 60

Identify which of the following financial instruments are required under IAS 39 Financial Instruments: Recognition and Measurement to be measured at amortised cost: $\begin{array}{|l|l|}\hline \text { I } & \text { Loans receivable } \\\hline \text { II } & \text { Debentures } \\\hline \text { III } & \text { Investments in associates } \\\hline \text { IV } & \text { Debt portion of a convertible note } \\\hline V & \text { Unfavourable derivative instruments } \\\hline\end{array}$

A)I, II and III
B)I, II and IV
C)II, III and IV
D)II, IV and V

Question 61

Explain how IAS 32 can require classification of a financial instrument as a liability,rather than equity,even though settlement of the instrument will be in the equity of the entity.

Question 62

Describe the key issue for determining the existence of a financial asset or financial liability.How does 'exchanging financial assets or financial liabilities with another entity under conditions that are potentially favourable or potentially unfavourable' help determine the classification of an instrument as an asset or liability?

Question 63

Distinguish futures contracts entered for hedge purposes from futures contracts entered for speculative purposes.

Question 64

What three characteristics must be established before an instrument is considered to be a derivative?

Question 65

What is a foreign currency swap and discuss why organisations enter into swap arrangements with other parties?

Question 66

IFRS 7 imposes further detailed disclosure requirements for which of the following credit risks?

A)the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.
B)the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities.
C)the risk that the fair value of a financial instrument will fluctuate because of changes in market prices.
D)the risk that the future cash flows of a financial instrument will fluctuate because of changes in market prices.

Question 67

Discuss the economic effect of issuing a compound instrument.

Question 68

Explain the reason for the rise in the development and use of financial instruments in recent years.Describe some of the key accounting issues regulators have had to face in light of this increased use and development.

Question 69

Explain how financial instruments would be classified as financial liabilities or equity instruments.

Question 70

If an entity issued a convertible note at a price of €40.00 and it was determined that a debt instrument of similar risk and rate of interest of 10%-but without the option to convert to equity-could be sold for €32.00,what would be the equity component of the convertible note?

A)€40.00
B)€32.00
C)€8.00
D)€12.00