Builders Ltd (‘Builders’) is a listed company in South Africa and operates in the home improvement sector in Southern Africa. It has retail shops and three strategically placed warehouses from where goods are transported to the shops. Builders’ year-end is 30 September.
The following transactions occurred during the 2015 financial year:
Transaction 1: Purchase of debentures On 1 October 2014, Builders purchased 100 000 12% debentures that were issued by one of their South African suppliers, Tradelit Ltd (‘Tradelit’). The company purchased them for R4 500 000, which was considered to be their fair value at that date. Transaction cost of R80 000 was incurred and paid.
The debentures will be redeemed after four years at 110% of the issue price. Interest on the debentures is payable annually on 30 September. Builders hold these debentures within a business model with the intention to collect contractual cash flows solely from capital and interest. At initial recognition, Builders determined that 20% of the future cash flows of the debentures will be lost if Tradelit defaults on the debentures. Builders further estimated a default probability of 5% over the next 12 months. Since initial recognition there was no significant increase in credit risk.
On 1 September 2015, the directors received a notice from Tradelit that they were experiencing severe financial difficulty and had applied for business rescue. Tradelit paid the interest due on 30 September 2015 in full, but will only be able to pay 70% of the remaining interest and capital. As a result of this notification Builders concluded that the financial asset is now credit impaired.
Transaction 2: Issue of preference shares One of the strategic goals of Builders is to expand their footprint to the rest of Africa with the main focus being the construction of low cost houses. Builders issued 200 000 8% cumulative preference shares on 1 October 2014 at R100 each. The dividend is payable annually on 30 September. In order to minimise the potential liquidity problems at maturity on 30 September 2019, Builders allowed the shareholders to either convert the preference shares into ordinary shares or redeem them at R105 each. If the preference shareholders choose to convert to ordinary shares, the number of ordinary shares to be issued, will be determined based on the share price of Builders as at 30 September 2019. The market interest rate is 9% for similar
preference shares.
These preference shares were issued in order to raise capital to finance the expansion project in the rest of Africa.
Transaction 3: Issue of debentures Builders also issued 500 000 8% convertible debentures at the nominal value of R10 each on 1 May 2015. Interest on the debentures is payable annually in arrears on 30 April. Each debenture could be converted into 4 ordinary shares with a par value of R2,50 each, at the choice of the debenture holder at any time on or before 30 April 2020. If the debentures are not converted it will be redeemed on 30 April 2020 at nominal value. A fair interest rate for similar debentures without conversion rights was 9% on 1 May 2015.
REQUIRED:
(a) Prepare the journal entries to account for Transaction 1: Purchase of debentures, in the accounting records of Builders Ltd for the year ended 30 September 2015. Ignore tax. Journal narrations are not required.
(b) Discuss how Transaction 2: Issue of preference shares, in terms of IFRS and more specifically IAS 32 Financial Instruments: Presentation, should be classified in the financial statements of Builders on 1 October 2014.
