There are 3 questions in the word file. Please see them before you decide to accept this question,

 

 

 

 

Question 1

 

Sondheim Corporation (SC) – an IFRS reporting corporation – manufactures an industrial product used in the oil and gas industry that requires a raw material with a purchase price that varies considerably depending on world supply and demand.

 

In late November 2016, the cost of the material is $100 per kilogram, its lowest price for the past eight months. In an attempt to benefit from the low prices, SC enters into a swap covering the purchase of 800 kilograms per month for December 2016 to May 2017 inclusive, in effect fixing the cost of these future volumes at $100 per kilogram. The counterparties settle with each other on a net cash basis at the end of each month.

 

The average price per kilogram over the period of the swap (and at each month end) was as follows:

 

                           $                                                          $

December         97                              March              117

January           104                              April                   92

February         105                              May                 101

 

Assume that the swap’s fair value at any month end is based on the outstanding undelivered (i.e.,unsettled) quantities under the contract and the price differential under the swap at that date. For example, at December 31, 2016, the fair value of the swap is determined as follows:

 

Total volume under contract                           = 6 months X 800 kg per month         = 4,800  kg

Less December volume settled                      = 1 month X 800 kg                            = (  800) kg

Volume remaining under contract, Dec. 31   = 5 months X 800 kg                          = 4,000  kg

 

SC pays fixed                                                 $100/kg

SC receives variable (Dec. 31 variable)            97/kg

Price differential, Dec. 31, 2016                     $    3/kg

 

Fair value of swap, December 31, 2016: $3 X 4,000 kg = $12,000

 

Required:

 

(a)  Identify the financial risks that SC was exposed to relative to the purchase of raw material before entering into the swap. Explain each exposure briefly.

(b)  Identify the financial risks that changed, and any new risks the company is exposed to as a result of entering into the swap, explaining each briefly.

(c)  Assume that SC does not designate this hedging relationship and therefore, does not use hedge accounting. Prepare all entries made by SC in December 2016 and January 2017 to record the monthly purchases of the material, and any entries required related to the swap. Assume all quantities of material purchased are sold in the same month as purchased.

(d)  Now assume that SC has documented the relationship as a cash flow hedge and uses hedge accounting. Prepare all entries made by the company in December 2016 and January 2017 to record the purchase of the material, and any entries required related to the swap.

(e)  Would SC’s management be motivated to use the special hedge accounting standards? Explain your answer.

(f)   Explain briefly how SC would account for the situation in (d) if the company reported under private enterprise accounting standards.

 

 

 

 

Question 2

 

It is late December, 2016 and Smithie Corp. is considering the issue of one of the two financial instruments described below:

 

a)    Series B 5% cumulative preferred shares, redeemable at the company’s option at $10.50 per share.

b)    Series C 6% preferred shares, redeemable in five years’ time. The company retains the option of redeeming the preferred shares by issuing Smithie Corp. common shares, with the number of common shares dependent on the market value of the common shares at the redemption date of the preferred.

 

Required:

 

For the two series of preferred shares described above, indicate how Smithie Corp. would have to present each of the two types of financial instruments on its financial statements: as debt or as equity. Explain your rationale for your decisions for each of the Series B and Series C preferred shares.

 

 

Question 3

 

In order to raise capital for a major plant expansion, Pebbo Ltd. (PL) issued $6 million of 7%, 10-year convertible bonds on September 1, 2016 at 109. Interest is payable annually on August 31 each year. The Vice-President Finance indicated at that time that the bonds could have been sold at a price of $6,441,580 to yield 6% if they had been issued without the conversion option.  Each $1,000 bond is convertible into 20 common shares of PL any time between September 1, 2018 and maturity.

On September 1, 2018, $1,500,000 face value of bonds are converted into common shares, which are then selling at $56 per share on the Toronto Stock Exchange, and another $3,000,000 face value are converted one year later on August 31, 2019 when the shares are selling at $62 each.

PL is a publicly accountable corporation and has an August 31 year end.

Required: (Hint: prepare a bond amortization table covering the three years from September 1, 2016 to August 31, 2019.)

1.    Prepare journal entries to record the issue of the convertible bonds on September 1, 2016; the conversion of $1,500,000 face value of bonds on September 1, 2018; and the conversion of the $3,000,000 face value of bonds on August 31, 2019. For these entries, you do not need to provide the entry for the payment of interest on the bonds that would be payable to the bondholders at these dates. Please show all calculations.

2.    You have been asked to prepare the annual financial statements at the close of business on August 31, 2019, identifying the balances of the following accounts associated with the convertible bonds and shareholders’ equity:

·         Bonds payable

·         Contributed Surplus – conversion options

·         Interest expense