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QUESTION ONE (20 MARKS)

TechGrow Ltd. is a technology company that has made the following financial transactions in 2023:

Purchased 10,000 shares of CloudSoft Inc. for R500,000 on January 1, 2023. TechGrow intends to hold these shares for long-term capital appreciation. The shares on 30 December 2024 have a fair value of R550 000.
Issued a 5-year bond with a face value of R1,000,000 on March 1, 2023. The bond pays 4% interest annually and was issued at par.
Provided a loan of R200,000 to a subsidiary on June 1, 2023, with an annual interest rate of 5%, to be repaid in full after 3 years.
Entered into a forward contract to sell 100,000 euros for R110,000 on December 31, 2023. The contract will be settled on June 30, 2024.
Required:

How should TechGrow classify and measure the above transactions? Also provide journal entries to account for the above transactions. (20)

1 answer

In order to classify and measure the transactions made by TechGrow Ltd., we need to understand the nature of each transaction and how they fit into financial reporting standards.

Transaction 1: Investment in CloudSoft Inc. Shares

Classification: This investment is classified as a financial asset measured at fair value through other comprehensive income (FVOCI) since TechGrow intends to hold these shares for long-term capital appreciation.

Initial Measurement: This will be recorded at cost of R500,000.

Subsequent Measurement: At year-end, the fair value will be assessed. The fair value on December 30, 2024 is R550,000.

Journal Entry on Initial Purchase (January 1, 2023):

Dr. Investments in CloudSoft Inc. Shares            R500,000
    Cr. Cash/Bank                                      R500,000

Journal Entry for Fair Value Adjustment (December 31, 2023):

Dr. Fair Value Adjustment (OCI)                       R50,000
    Cr. Investments in CloudSoft Inc. Shares            R50,000

Transaction 2: Issuance of Bond

Classification: Bonds payable are classified as a liability and measured at amortized cost.

Initial Measurement: The bond is issued at par for R1,000,000 with an interest rate of 4%.

Journal Entry for Issuance of Bond (March 1, 2023):

Dr. Cash/Bank                                    R1,000,000
    Cr. Bonds Payable                               R1,000,000

Journal Entry for Annual Interest Payment (March 1, 2024):

Dr. Interest Expense                               R40,000
    Cr. Cash/Bank                                   R40,000

Transaction 3: Loan to Subsidiary

Classification: The loan provided is classified as a financial asset and will be measured at amortized cost.

Initial Measurement: Recorded at R200,000.

Interest income accrued:

Journal Entry for Provision of Loan (June 1, 2023):

Dr. Loan to Subsidiary                            R200,000
    Cr. Cash/Bank                                   R200,000

Journal Entry for Interest Income Accrued (December 31, 2023):

  • Interest for 7 months (June - December 2023) = R200,000 * 5% * 7/12 = R5,833.33
Dr. Interest Receivable                            R5,833.33
    Cr. Interest Income                             R5,833.33

Transaction 4: Forward Contract

Classification: The forward contract will be classified as a derivative asset or liability, depending on its valuation at each reporting date. Since it’s a contract to sell currency, its fair value will be determined at settlement.

Assuming the value of the forward contract remains R110,000, it's a financial asset.

Journal Entry for the Forward Contract (December 31, 2023): Since the forward contract is not settled yet, we record the gain or loss in the period of accounting. Assuming the contract's value is unchanged at R110,000:

Dr. Forward Contract Asset                        R110,000
    Cr. Other Income/Unrealized Gain                 R110,000

Summary of Journal Entries:

  1. Investment in CloudSoft Inc. Shares
    • Purchase: R500,000
    • Fair Value Adjustment: R50,000 gain
  2. Issuance of Bonds
    • Issued at par: R1,000,000
    • Interest Payment: R40,000 annual
  3. Loan to Subsidiary
    • Issued Loan: R200,000
    • Accrued Interest: R5,833.33
  4. Forward Contract
    • Recorded at fair value: R110,000

When preparing the financial statements, these transactions will be reflected in the respective balance sheet and income statement sections, contributing to the overall financial position and results of operations for TechGrow Ltd.