AC2101 SEMINAR 10

Financial Assets III

PROJECT TEAM 4
Goh Ying Ying Daphne
Caleb Wu Kye
Melissa Goh Li Ting
Maria Farah Bonsobre

1
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PART 1
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(1)
“Under SFRS(I) 9 Financial Instruments, the 12 month
expected credit loss (ECL) is a subset of the lifetime ECL ”
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(1)
“Under SFRS(I) 9 Financial Instruments, the 12 month expected
credit loss (ECL) is a subset of the lifetime ECL ”

“Twelve-month ECL is the portion of lifetime ECLs associated with the

possibility of a loan defaulting in the next 12 months.
It is not the expected cash shortfalls over the next 12 months but the
effect of the entire credit loss on a loan over its lifetime, weighted by
the probability that this loss will occur in the next 12 months.”
TRUE
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(1)
“Under SFRS(I) 9 Financial Instruments, the 12 month expected
credit loss (ECL) is a subset of the lifetime ECL ”

TRUE

Seminar 9 Slide 15
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(2)

“Under SFRS(I) 9, a convertible bond held as a financial

asset will not pass the SPPI (solely payments of
principal and interest) test and will be accounted for as
fair value through profit and loss.”
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(2)
“Under SFRS(I) 9, a convertible bond held as a financial asset will not
pass the SPPI (solely payments of principal and interest) test and will
be accounted for as fair value through profit and loss.”

What is a convertible bond?

A type of bond that the holder can convert into a

specified number of shares of common stock in the
issuing company or cash of equal value.
TRUE
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(2)
“Under SFRS(I) 9, a convertible bond held as a financial asset will not
pass the SPPI (solely payments of principal and interest) test and will
be accounted for as fair value through profit and loss.”
SFRS (I) 9 B4.1.14
“The contractual cash flows are not SPPI because they reflect a
return that is inconsistent with a basic lending arrangement ie
the return is linked to the value of the equity of the issuer.”
SFRS (I) B4.1.7A
“... contractual terms that introduce exposure to risks or volatility in
TRUE the contractual cash flows that is unrelated to a basic lending
arrangement, such as exposure to changes in equity prices or
commodity prices, do not give rise to contractual cash flows that are SPPI
on the principal amount outstanding.”
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(2)
“Under SFRS(I) 9, a convertible bond held as a financial asset will not
pass the SPPI (solely payments of principal and interest) test and will
be accounted for as fair value through profit and loss.”

Thus it falls under the residual category of FVPL.

TRUE
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(3)
One problem with recycling is that gains or losses pertaining to
a financial asset (for eg. FVOCI debt security) appears in two
places - once in other comprehensive income (OCI) and later in
profit and loss upon derecognition, resulting in double-counting
in total comprehensive income (TCI)
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(3)
One problem with recycling is that gains or losses pertaining to a financial
asset (for eg. FVOCI debt security) appears in two places - once in other
comprehensive income (OCI) and later in profit and loss upon derecognition,
resulting in double-counting in total comprehensive income (TCI)

No double counting. Only a reclassification of the

unrealised FV gain/loss (OCI) to P/L.
The amount in FV Reserve is zeroised against the P/L.
E.g. Dr FV Loss on disposal of debt security (P/L)
FALSE Cr FV Reserve (OCI)
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PART 2
For each of the financial instruments below, discuss whether the
instrument has contractual cash flows that are solely payments of
principal and interest (SPPI) under SFRS(I) 9
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Definition of SPPI SFRS(I) 9: B4.1.7A

IS A SPPI NOT A SPPI

Contractual cash flows that are SPPI on the principal Contractual terms that introduce exposure to risks or
amount outstanding are consistent with a basic lending volatility in the contractual cash flows that is unrelated to
arrangement (BLA). a BLA.

BLA considerations: Eg. Exposure to changes in equity prices or commodity

1. Time Value of Money prices
2. Credit Risk
Note: Contractual cash flows that are SPPI are consistent with a BLA.
3. Basic lending risks eg. liquidity risk In a BLA, consideration for TVM and credit risk are typically the most significant
elements of interest. However, in such an arrangement interest can also include
4. Costs eg. administrative costs consideration for
5. Profit margin consistent with a BLA other basic lending risks (e.g. liquidity risk) and costs (e.g. admin costs) associated
with holding the FA for particular period of time. In addition, interest can include a
profit margin that is consistent with a BLA.

On the other hand, like it was mentioned earlier, contractual terms introduce
exposure to risks or volatility in the contractual cash flows that is unrelated to a
BLA, such as changes in equity or commodity prices, are not considered SPPI.
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(1)

A loan of $500m to Entity A at an interest rate of 5%, repayable in

5 years. At the end of the loan period, the lender will receive an
additional 10% of the loan amount if Entity A’s return on assets
during the maturity year is more than 15%.
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(1)
1. Amount received by lender is determined by the Return on
Asset
2. ROA is not a typical part of a lending arrangement nor is it
consideration for the basic element of TVM or Credit Risk

∴ SPPI
Note: ROA and related indicators are
performance conditions, when incorporated into
the bon/loan instrument is not a basic lending
arrangement
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(2)

A 10-year bond with a fixed coupon interest of 8%, payable

semi-annually. If any coupon payment is missed, the coupon
interest is reset to 12% for subsequent coupon payments.
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(2)
From SFRS(I) 9: B4.1.10,

1. ↑ coupon interest rate is to compensate ↑ in credit risk

2. Not affected by prices of other items and solely based on the missed coupon payment

∴ SPPI
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(3)
A perpetual bond but the issuer may call the bond at any point and
pay the holder the par amount plus accrued interest due. The
instrument pays a market interest rate but payment of interest
cannot be made unless the issuer is able to remain solvent
immediately afterwards. Deferred interest does not accrue
additional interest.
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(3)
From SFRS(I) 9: B4.1.14 Instrument H,
1. Interest amounts not consideration for TVM
on principal amount outstanding

2. Remaining solvent is not a consideration

that affects BLA.

∴ SPPI
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(4)
A bond with a stated maturity date. Interest payments are
indexed to an equity index of the issuer’s country.
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(4)
From SFRS(I) 9: B4.1.7A,

From SFRS(I) 9: B4.1.13 Instrument A,

1. “...indexed to an equity index of
the issuer’s country.”

∴ SPPI
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(5)
A non-financial institution holds a bond which pays LIBOR +
3%. The contractual provisions of the instrument establish that
if the issuer credit rating deteriorates, the interest rate of the
entire instrument will be reset to LIBOR +4%.
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(5)

LIBOR:
London Inter-bank Offered Rate is the average of interest rates estimated by each of the leading
banks in London that it would be charged were it to borrow from other banks.

1. ↑ interest rate is to compensate ↑ in credit risk

→ In line with BLA

∴ SPPI
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(6)
A loan to Entity B of $5m at a fixed interest rate of 10% for five
years. Entity B has the option to repay the full amount of the
loan at any time, including any accrued interest as well as a
prepayment penalty. The prepayment penalty is set at an initial
value of 5% of the loan amount, and is reduced by 1% for each
complete one year that the loan remains outstanding.
Note: this is a grey area.
Compensation for a lower profit margin and part
of the consideration for interest under a BLA
Is 5% substantial?
Substantial and reasonable not really defined
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(6)
From SFRS(I) 9: B4.1.11,

1. It aims to collect interest and principal amount.

2. Penalty is in consideration under BLA.

∴ SPPI
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PART 3
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(a) Calculate the effective interest rate for the investment in bonds
by Sitoh Ltd.
(b) Prepare the journal entries for Sitoh Ltd to record all the
transactions in respect of its investment in the five-year bond
for the years 20x1 through 20x3.
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Sitoh Ltd has a 31 December financial year end and complies with SFRS(I) 9 Financial Instruments.
On 1 January 20x1, Sitoh Ltd pays $175,581 to acquire a bond which has a nominal value of
$200,000, a coupon rate of 10% interest per annum payable on 31 December each year and matures
on 31 December 20x5. Besides the payment above, Sitoh Ltd incurs transaction costs of $10,000.
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(a)Calculate effective interest rate Sitoh’s Bond

From FC:
» N=5
» PV = - (175,581 + *10,000) (*SFRS(I) 9 5.1.1)
» FV = 200,000
» PMT = 20,000 (10% x 200,000)
» EIR = 12%
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(b) Prepare the journal entries for Sitoh Ltd from

20X1 to 20X3
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Sitoh Ltd’s business model for this class of financial asset is to “collect contractual cash flows”.
On initial recognition of the bond, the 12 month expected credit loss is $5000
● Sitoh’s Business Model is “collect contractual cash flows”, hence classify and measure
it the bond under Amortised Cost

● Initial recognition → 12 month ECL (interest revenue recognise base on gross

carrying amount)
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On 31 Dec 20x1, it is determined that the bond issuer is in financial distress and the bond is
considered to be credit impaired. The lifetime expected credit loss is computed to be $46,406.

1/1/20X1 Dr Investment in Bond 185,581

Cr Cash 185,581

Dr Impairment Loss 5,000

Cr Loss Allowance 5,000

31/12/20X1 Dr Cash 20,000

Dr Investment in Bond 2,270
Cr Interest Income 22,270

Dr Impairment Loss 41,406 *46,406-5,000

Cr Loss Allowance 41,406
Original Amortisation Table

Year Coupon Interest Interest Income @ Changes in

Gross CA
ending Received @ 10% 12% Gross CA
1/1/X1 185,581
31/12/X1 20,000 22,270 (2,270) 187,851
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On 31 December 20x2 the bond continues to be credit impaired and the lifetime
expected credit loss is computed to be $50,132.

31/12/20X2 Dr Cash 20,000

Dr Investment in Bond 2,542
Cr Interest Income 16,973
Cr Loss Allowance 5,569

Dr Loss Allowance 1,843

Cr Impairment Loss 1,843 *51,975-50,132

Original Amortisation Table

Year Coupon Interest Interest Income Changes in Loss Amortised Interest

Gross CA
ending Received @ 10% @ 12% Gross CA Allowance amount Income

1/1/X1 185,581
31/12/X1 20,000 22,270 (2,270) 187,851 46,406 141,445
31/12/X2 20,000 22,542 (2,542) 190,393 50,132 140,261 16,973
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On 31 December 20x3, in a negotiated settlement, the bond is redeemed for $175,000

(inclusive of interest for 20x3). In all of the years, coupon payments were duly made.

31/12/20X3 Dr Cash 175,000

Dr Loss Allowance 50,132
Cr Investment in bond 190,393
Cr Interest Income 16,831
Cr Gain on Bond 17,908

Original Amortisation Table

Year Coupon Interest Interest Income Changes in Loss Amortised Interest

Gross CA
ending Received @ 10% @ 12% Gross CA Allowance amount Income

1/1/X1 185,581
31/12/X1 20,000 22,270 (2,270) 187,851 46,406 141,445
31/12/X2 20,000 22,542 (2,542) 190,393 50,132 140,261 16,973
31/12/X3 16,831
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PART 4
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Sitoh Ltd has the following provision matrix and the gross carrying amount of trade
receivables on 31 December 20x1.

1 to 30 31 to 60 61 to 90 More than 90
Current days past days past days past days past
due due due due

Expected
Default Rate 0.3% 1.5% 3.5% 6.5% 10.5%

Gross CA of
Trade 10M 8M 3M 1M 1M
Receivables
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The balance on 1 January 20x1 of the allowance for impairment of trade receivable
account was $200,000 and during the year $10,000 of trade receivables were written
off. Sitoh Ltd uses the “simplified approach” of recognising lifetime expected credit
loss for its trade receivables.
Allowance for Impairment

Write off 10,000 Bgn Bal $200,000

Current* $190,000
Bal

Current balance: $190,000 (200,000-10,000)

Estimated Allowance for the year:
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1 to 30 31 to 60 61 to 90 More than 90
Current days past days past days past days past
due due due due

Expected
Default Rate 0.3% 1.5% 3.5% 6.5% 10.5%
X
Gross CA of
Trade 10M 8M 3M 1M 1M
Receivables
=
WORKING 30,000 120,000 105,000 65,000 105,000

Current balance: $190,000 (200,000-10,000)

Estimated Allowance for the year: $425,000 (30,000+120,000+105,000+65,000+105,000)
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1 to 30 31 to 60 61 to 90 More than 90
Current days past days past days past days past
due due due due

Expected
Default Rate 0.3% 1.5% 3.5% 6.5% 10.5%
X
Gross CA of
Trade 10M 8M 3M 1M 1M
Receivables
=
WORKING 30,000 120,000 105,000 65,000 105,000

Current balance: $190,000 (200,000-10,000)

Estimated Allowance for the year: $425,000 (30,000+120,000+105,000+65,000+105,000)
Adjustment (Increase) $235,000 (425,000-190,000)
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The balance on 1 January 20x1 of the allowance for impairment of trade receivable
account was $200,000 and during the year $10,000 of trade receivables were written
off. Sitoh Ltd uses the “simplified approach” of recognising lifetime expected credit
loss for its trade receivables.
Allowance for Impairment

Write off 10,000 Bgn Bal $200,000

Adjusting 235,000
31/12/20X1 Dr Impairment loss on TR 235,000 entry
Cr Allowance for Impairment TR 235,000
Ending 425,000
Bal

Current balance: $190,000 (200,000-10,000)

Estimated Allowance for the year: $425,000 (30,000+120,000+105,000+65,000+105,000)
Adjustment (Increase) $235,000 (425,000-190,000)
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Thank You