Advanced Accounting Concepts

Table of Contents

Introduction.

Review and analysis of convertible notes and related aspects:

Understanding of relevant Australian Accounting Standard along with ASX rules and other relevant precedents:

Conclusion.

References.

Introduction to Western Australia State

The Western Australia State is known as State of opportunity, excitement and growth. It is also known for its complex financial instrument as this market include warrants, derivatives, bonds, etc. and which are traded in the Australian Securities Exchange (ASX), this ASX is owned by Australian Securities Exchange Ltd. It is the primary security exchange and trade-in equity, bond, derivatives, etc. As in the present case, we will discuss the financial agreement entered by the company Zimmap Limited with Company Royal Financing Ltd, issued $25 million convertible notes to Royal at face value for three years at the fixed interest rate, therefore we had discussed its accounting and disclosure along with accounting concept, fair value (Having correct valuation technique) and compounded financial instrument. As the company had issued the convertible notes there it had two component debt and equity which is explained in the file. We had also discussed other accounting standards of Australia and ASX Rules and process along with the impact on profitability and disclosure in Financial Statement due to this financial agreement between two companies.

Review And analysis of Convertible Notes and Related Aspects:

The company Zimmap Limited (Australian based company) had issued the convertible notes of $ 25 million to Royal Financing Limited (Canadian based company) for financing and marketing agreement. These funds will be used by the Zimmap Limited for immediate extension of its production capacity. Since the convertible notes are issued by the company Zimmap, therefore the company had to do properly accounting and disclosure in it’s boos of accounts.

Meaning of convertible notes: It is a type of date instrument through which a company may raise funds with a promise to convert these notes into equity of the organization. This conversion option can be exercised by the person giving debt on company and they may give option at the end of maturity to redeem in cash or convert into equity shares.

The convertible notes issued by the company which are mature within fix period of time as in the present case convertible notes issued by Zimmap for three years, the recipient of these notes had an option at the end of maturity period of three years to opt for cash or to convert its notes into equity. Therefore as they can be converted into equity, so we can say that it have both debt and equity component which is commonly known as Compound financial instrument (embedded derivative).The company had to do accounting of both equity and debt over the period of time as per the relevant accounting standard. As the Zimmap is an Australian based company, therefore it will follow the Australian Accounting Standard for accounting and disclosure of convertible notes. Therefore the company had to follow the Australian Accounting Standard Board (AASB) for recording the concern convertible notes contract.

Review of convertible notes in detail issued by Zimmap Ltd:

In the current scenario, Zimmap Limited has made agreement with royal financing Limited. As per the agreement, first mentioned company is required to issue convertible notes of $25million on 12 February, 2020. These notes are run for the period of 3 years and attract a fix rate of interest. In return, Royal financing shall give non exclusive marketing rights for the same period.

Accounting implications will be as per the standards that are issues by the Australian accounting body so that a business man may adopt this to apply unique standards for recording and accounting business. This accounting body issues various types of Australian accounting standards from time to time. AAS 9 which deals with financial instruments and describes recognition criteria other disclosure requirements for Zimmap Limited as per Australian accounting standards are as follows:

Accounting implications:

 As per Australian accounting standards 9 - financial instruments (detailed explanation given in part 2 to this report), the above financial agreement relates to compound financial instrument (embedded derivatives) in which one portion is treated as equity and other portion is treated as debt component. The company is required to recognize in its books of accounts, these two components separately in fair its fair value. The accounting of these two components is as follows:

  • For debt (liability) portion: For calculating the fair value of liability portion, the contractual stream of future cash flows discounted at the given interest rate. Calculation of fair value of debt component are as follows:

1. Fair value 2 of convertible notes as a whole:

 Face value per convertible note = $1(assume)

 Number of convertible notes = $ 25 millions

Total fair value 2 of convertible notes = $25 millions

2. Fair value of the liability portion:

 Interest rate =10% (assume)

Risk free interest rate = 4% (assume)

Year

Coupon

Principal

Total cash flow

Discounting factor (Three digit)

Present value

1

1 million

-

1 million

0.909

.909 million

2

1 million

-

1 million

0.826

0.826 million

3

1 million

25 million

26 million

0.751

19.526 million

Total debt = 21.261 million

  • For equity portion: The fair value equity portion is the residual amount which is exist after deducting the fair value of liability component from the total value of compound financial instrument i.e. the value of convertible notes issued by company.

Total value of convertible notes = $25 million

Less: value of debt component = $21.261 million

 Value of equity portion = $3.739 million

That is to say that the amount of dollar 25 million should be deducted from amount of liability portion which is calculated through fair value calculations and the residual value which comes is the value of equity portion.

Disclosure requirements:

As per the relevant Australian accounting standards, certain disclosure required to be presented in the financial statement of such company relating to financial instrument. The main disclosure regarding embedded derivatives is as follows:

  • Information about significance of financial instrument.
  • Information regarding nature and extent of risks involve in financial instrument.
  • Effect of financial instrument on the financial position and performance of the company and this includes fair value of financial assets measured fair value of financial liability measured.
  • Disclosure requirement to such company for ending 30 June is that it requires following guideline give in Australian accounting standards 7. According to which, it is required to present such instrument in its financial statements as fair value basis (Kaplanand Atkinson2015).
  • Also Zimmap Ltd. requires continuous recognizes such financial instrument in next year through fair value basis.

At last, the conclusion of above report relating to two compound financial instruments can be summarized in following ways:

Summary of conclusions:

  • The company is in good financial position to accept this agreement because production capacity can be enhanced by having non exclusive rights of royal financing.
  • Although, Zimmap Ltd. Is required either to repair debt after 3 years or to issue equity shares of $25 million (Groot and Selto, 2013).
  • As per relevant Australian accounting standards, disclosure requirement is mandatory at every yearend up to the period of convertible notes
  • A disclosure requirement includes yearend fair valuation of convertible notes and also includes fair valuation of debt portion and equity portion of such convertible notes.

Assumptions made:

In calculating the fair value of financial instrument for recognition purpose, following assumptions are made:

  • Face value of one convertible notes equals to $1 because there is no information given regarding this aspect.
  • The interest rate that is applicable to convertible notes is 10% per annum; this is taken as per the conditions which generally exist in Australian securities market.
  • Risk free interest rate which is given in Australia is 4% per annum.
  • There is a assumption that Zimmap Ltd has already decided what quantity of shares shall be given at the end of three year in exchange of convertible notes as given in convertible notes deed.

Understanding of Relevant Australian Accounting Standard Along with Asx Rules and Other Relevant Precedents:

Australian Accounting Standards are the standards which are used to accounting and disclosure purpose for books of accounts of the companies incorporated in Australia and/ or governed by the Australian Companies Act. These accounting standards are governed by Australian Accounting Standard Board (AASB). As now, International Accounting Reporting Standards (IFRS) are also applicable which governs the accounting in the whole world.

As in the present case, Company Zimmap Limited which is listed in ASX had come into agreement of financing and marketing with the Canadian company named as Royal Financing Ltd. For this agreement, Zimmap had issued $25 million convertible notes for the period of 3 years at fixed interest rate along with nonexclusive marketing rights for 3 years.

For accounting of convertible notes and the contract between the companies, AASB – 9 will be used which is deal with accounting for financial instrument Therefore, AASB 9 will be used for accounting of Convertible note. As per AABS-9, applies to financial assets, financial liabilities, hedging accounting and impairment (Mortenson and Mortenson, 2017).

Therefore AASB-9 mainly covers the following three main terms:

  • Measurement and classification of financial instrument
  • Impairment Model of financial assets
  • Hedge accounting
  • Measurement and classification of financial instrument: It include financial assets and liabilities

Financial asset includes cash, equity component, contractual right to receive cash or other financial assets, bond, convertible notes, derivatives etc. They are initially measured at its fair value plus, through profit and loss if financial asset not value at fair value, transaction cost which are directly related to purchase of financial asset (Shah, 2013). These are classified according to the contractual cash flow characteristics test. Explained as follows:

Particulars

Contractual cash flow for testing characteristic

Pass

Fail

Business Model

Financial assets which are held to collect contractual cash flow (Interest and principal)

Amortised Cost

FVTPL

Held For Sale in short term

FVTPL

FVTPL

Held for business model with both collecting cash flow of contract and financial asset sale

FVOCI (recycling yes)

FVTPL

options

Elected Conditional fair value

FVTPL

-

Option elected for convert in equity shares , not held for trading in OCI

-

FVOCI (recycling no)

Financial liabilities includes an obligation of contract for delivering cash or financial asset or exchange of financial asset or liability with another asset or liabilities, an contract which may settled in the entities own equity instrument and is a derivative or non-derivative in exchange of other financial asset or liability (Bailey and Samuels, 2018).

Examples of financial liabilities are trade creditors, issued bonds, bank borrowing, convertible notes, derivative such as options etc.

Financial liability are recorded at its fair value minus, through profit and loss if financial liability not value at fair value, transaction cost which are directly related to issue of financial liabilities. Subsequently at amortised cost and for some cases from profit and loss like derivatives financial guarantee contract etc.

  • Impairment Model: The impairment model of financial asset is based on the forward looking expected credit loss model. This model is applied to the debt instrument which is measured at amortised cost or at FVOCI like trade receivable, lease receivable etc.
  • Hedging Accounting: This accounting technique is used for mitigating the risk of loss in financial statement. Most of the hedging accounting will never change the result of AASB – 9. This always is an optional. Three type of hedging relationship exist – Fair value Hedge, Cash Flow Hedge and Hedge of net investment for foreign operations (Gissel, 2016).

Therefore, we can conclude that in the report to Sam the CFO of Zimmap Limited for the contact entered with Royal Finance Limited and issuing $25 million convertible notes, for the accounting and its discloser it is proposed that AASB – 9 will be recommended as this is cover under the Compound instrument where it is an contractual obligation of Zimmap Limited to deliver cash to Royal Finance Limited after the period of three years if they opt for cash and if they opt for equity instrument then the fixed no. of shares as which is equivalent to notes value at that time.

ASX rules and other relevant precedents:

ASX stands for Australian Securities exchange located in Sydney, New south Wales, Australia. They manage the stocks listed their land deals with listing and conduct of listed companies. They also framed the rules which are enforceable against all the companies listed there and all the associates under the Corporation Act. And if any of the listed entity does not comply with listing rules then their security is suspended.

The listing rules of ASX divide the securities in Debt securities and equity securities. Debt Security means bond, notes etc. whereas equity means shares, unit of trust, convertible security etc.

The Convertible means a security that may be converted at the will or as per contact with consent of its holder by the issuer as per rules of ASX and in the present case “Sam” company have to issue the convertible notes to “Royal” which may at the option of Royal may be converted into shares after three years.

The rules that the companies to be followed for listing of securities are as follows:

  • Satisfaction of minimum standard of quality, size, sufficient information given by the entity
  • Demonstration of security by the entity before investor before entering into the official list and its securities quoted
  • As per acceptable accounting and standard of auditing, financial statements are prepare and presented
  • Security holder approval requires for certain significant transaction.
  • All the information which may have material impact on price of security, timely disclosure is required for such information.

As for the company Zimmap Limited it is require following all the above rules for issuing the convertible notes to Royal Financing Limited and if after three years, Royal Company wants to convert the notes into equity then the proper and appropriate accounting framework and rules of ASX should be complied with (Ganda, 2014).

Conclusion on Advanced Accounting Concepts

It is concluded that for issue of convertible notes by Zimmap to Royal, it is important for the company to follow the accounting and discloser as per AASB – 9 and treat is as Compounded instrument with the option to opt for cash or shares after three years. We had also discussed about the marketing arrangement in relation to this financial arrangement along with advance accounting concepts and discussion on fair value of convertible note deed. Since the such organisation is required to issue the convertible note, therefore it become important for the company to follow Australian Securities Exchange’s rules and regulations and issue the security as per the guidance discussed above since ASX had framed rules for listing securities which are enforceable in court of law.

References for Advanced Accounting Concepts

Hoyle, J.B. and et al. 2015. Advanced accounting. McGraw Hill.

Peters, P. And et al. 2014. Learning essential terms and concepts in Statistics and Accounting. Higher Education Research & Development. 33(4). pp.742-756.

Kaplan, R.S. and Atkinson, A.A. 2015. Advanced management accounting. PHI Learning.

Wiedenhofer, D and et al. 2019. Integrating material stock dynamics into economy-wide material flow accounting: concepts, modelling, and global application for 1900–2050. Ecological economic. 156. pp.121-133.

Groot, T. and Selto, F.H. 2013. Advanced management accounting (pp. 339-378). London: Pearson.

Islam, J. And et al. 2018. Politicisation of the accounting standard-setting process and the influence of key-players: An investigation into the withdrawal of the mandatory status of the Statement of Accounting Concepts No. 4 (SAC 4) in Australia. Accounting History. 23(3). pp.296-313.

Vician, C. and Mortenson, K.G. 2017. Integrating Accounting Themes with Enterprise System Experiences: An Accounting Department's Journey. AIS Educator Journal. 12(1). pp.34-58.

Beams, F.A. and et al. 2016. Advanced accounting. Pearson Education Limited 2018.

Shah, P. 2013. Financial Accounting. OUP Catalogue.

Bailey, W.J. and Samuels, J.A. 2018. Analyzing Two Investments—An Instructional Case to Introduce Basic Financial Accounting Concepts. Issues in Accounting Education Teaching Notes. 33(4). pp.18-29.

Gissel, J.L. 2016. A case of fixed asset accounting: Initial and subsequent measurement. Journal of Accounting Education. 37. pp.61-66.

Ganda, F., Ngwakwe, C.C. and Ambe, C.M. 2014. Independent research and a deep approach to learning of accounting concepts: Students’ view. Mediterranean Journal of Social Sciences. 5(6). pp.75-75.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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