Question

(b) On 1 July 2020 Octavio Ltd acquired some corporate bonds issued by Garnish Ltd. These bonds cost $11,682,000. They had a face value of $10 million and offered a coupon rate of 10 per cent paid annually ($1 000 000 per year, paid on 30 June). The bonds would repay the principal of $10 million on 30 June 2025. At the time the market only required a rate of return on 6 per cent on such bonds. We will assume that the market's required rate of return on these financial instruments remains at 6 per cent throughout the life of the bonds. Octavio Ltd operates within a business model where bonds are held in order to collect contractual cash flows and there is no intention to trade them. Assume that there were no direct costs associated with acquiring the bonds. (The use of Present Value and Annuity tables are required. Please refer Appendix A & B of your prescribed textbook) Required: 1. Explain why the company was prepared to pay $11 682 000 for the bonds given that, apart from the interest, they expect to receive only $10 million back in five years. (2 Marks) 2. Determine whether Octavio Ltd can measure the bonds at amortised cost. (1 Marks) 3. Calculate the amortised cost of the bonds as at 30 June 2021 to 30 June 2025. (4 Marks) 4. Provide the accounting journal entries for 1 July 2020 and the years ending 30 June 2021 and 30 June 2025. (3 Marks)

Answer 1

E9 X f =PV(E5, E6,-E7,-E8) A В C D E F Н - к L 1 2 3 4 5 6 7 Rate Nper Pmt FV PV FV-PV 1 Bond Price =Present Value of future cash flows They paid more because coupon rate was more than required rate of return The Present Value of cash flows discounted at required return rate is= $11,682,000 Discount rate(Required rate of return) 6.00% Number of years (2025-2020) 5 Annual Coupon Payment ($10 million*10%) $1,000,000 Payment at maturity $10,000,000 Bond Issue Price $11,684,946 (Using PV function of excel with Rate=6%, Nper=10, Pmt=-1000000, Fv=-10000000) Bond Premium (11684946-10000000) $1,684,946 NOTE:As per excel, the price should be $11684946 The difference may be due to approximation For accuracy of amortization, we take the accurate figure of $11,684,946 8 9 10 11 12 13 14

The difference may be due to approximation For accuracy of amortization, we take the accurate figure of $11,684,946 AMORTIZATION SCHEDULE Market rate=6% 10000000*10 *Previous Book % value B С А D=B-C E F G=F+E Account Date July1, 2020 June 30, 2021 June 30, 2022 June 30,2023 June 30,2024 June 30,2025 Debit Balance Debit Amortization in Bond Balance in of Bond Premium Debt Security Book value Cash Interest Income Premium Account of the Bond $1,684,946 $10,000,000 $11,684,946 $1,000,000 $701,097 $298,903 $1,386,042 $10,000,000 $11,386,042 $1,000,000 $683,163 $316,837 $1,069,205 $10,000,000 $11,069,205 $1,000,000 $664,152 $335,848 $733,357 $10,000,000 $10,733,357 $1,000,000 $644,001 $355,999 $377,358 $10,000,000 $10,377,358 $1,000,000 $622,642 $377,358 ŞO $10,000,000 $10,000,000

CREDIT JOURNAL ENTRY ON July1, 2020 ACCOUNT TITLES Held to Maturity Debt Security Bond Premium Cash DEBIT $10,000,000 $1,684,946 $11,684,946 CREDIT JOURNAL ENTRY ON JUNE 30, 2021 ACCOUNT TITLES Cash Bond Premium Interest Income DEBIT $1,000,000 $298,903 $701,097 CREDIT JOURNAL ENTRY ON JUNE 30, 2022 ACCOUNT TITLES Cash Bond Premium Interest Income DEBIT $1,000,000 $316,837 $683,163

CREDIT JOURNAL ENTRY ON JUNE 30, 2023 ACCOUNT TITLES Cash Bond Premium Interest Income DEBIT $1,000,000 $335,848 $664,152 CREDIT JOURNAL ENTRY ON JUNE 30, 2024 ACCOUNT TITLES Cash Bond Premium Interest Income DEBIT $1,000,000 $355,999 $644,001 CREDIT DEBIT $11,000,000 JOURNAL ENTRY ON JUNE 30, 2025 ACCOUNT TITLES Cash Bond Premium Interest Income Held to Maturity Debt Security $377,358 $622,642 $10,000,000