You have been allocated three new clients by your audit partner. As part of the audit process you have identified a number of issues and you have arranged a meeting with the audit partner to discuss.
Following the meeting the audit partner asked you to prepare a detailed report that includes an explanation and analysis of the relevant IAS’s (including definitions where appropriate) for each of the scenarios below. This report should also include your calculations, extracts from the Financial Statements (if relevant) and what disclosures, if any should be made. Your report should also consider any questions your client may have.
Calculations should be shown in an appendix.
Giro prepares its accounts to 30 June each year. The company owns and operates and item of plant that cost €960,000 and had accumulated depreciation of €670,000 on 1 July 2015. Depreciation policy is 10% of the cost and is calculated monthly. On 1 October 2015, the plant was damaged. The plant now operates at reduced capacity and it is estimated that its remaining useful life will only be two years. Unfortunately, it is not possible to repair the plant due difficulties in finding replacement parts. Based on the reduced capacity the estimated present value of the plant in use is €120,000. The plant has a current disposal value of €30,000 (which will be nil in 2 years’ time).
Email from client
“Now that we have had a chance to discuss possible financing arrangements, the directors are in agreement that we should structure our issue of financial instruments in order to be able to classify them as equity rather than debt. Any increase in the gearing ratio would be unacceptable. Therefore we have decided to make two issues of financial instruments as follows:
1. An issue of non-redeemable preferred shares to raise €5 million. These shares will carry a fixed interest rate of 8% and because they are shares they can be classified as equity.
2. An issue of 7% convertible bonds, issued at par value to raise €10 million. These bonds will carry a fixed date for conversion in 4 years’ time. Each €100 of debt will be convertible at the holder’s option into 200 €1 shares. In our opinion, these bonds can actually be classified as equity immediately because they are convertible within five years on terms that are favourable to the holder.”
Note – market rate for similar non-convertible bonds is 9%