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Initial debenture

the purpose of this video is to give you some background on financial instruments at amortized cost with reference to dementia specifically as the example they are off with a debenture there are two parties involved you have the party issuing the debenture that are seeking to get financed from that debentures and then the investor who is giving the money across to the issuer and investing in the debenture the investor gets interest from this arrangement so earns a return that is paid to him by the issuer and the issuer receives the capital upfront for whatever financing purpose he may have at the maturity date of the debenture then the money is repaid to the issuer to the investor so there's a cash flow wise there's a capital cash flow upfront from the investor to the issuer and at the end that kept cash flow is reversed and in the interim there is interest paid by the issuer to the investor the debenture as we've said now has interest associated with with it and that interest is based on the poor value of the debenture Thoms by nominal interest rate but the debenture doesn't necessarily have to be issued by the issuer at this pole right he might choose to issue this debenture at a discount where the premium and their decision interacts with the interest rate because it affects the whole return on on this investment instrument so coming to the accounting now for this investment instrument you have in your investors books and investments he's invested in these debentures to earn a return and you have a liability with the issuer as he needs to pay the money back to the investor at the end of the lease term as well as interest over the period so those are the performance obligations you're looking at and it's conceptionally a liability in terms of the framework now for your initial recognition for either the investment of the liability you're looking at fair value this fair value is based on the future cash flows from mr. burnshaw which are the interest amounts and in the redemption capital amount all of those amounts will be discounted back to a present value and this is the amount that must be used for your initial recognition if this amount defers from what was actually paid and received by the issuer and the investor respectively you need to do a day 1 adjustment to this fair value and that's recognized in your profit and loss on the first day of this economic event then you may also have transaction costs these transaction costs may be incurred by the investor and all the issuer and now not between these two parties these parties would probably work both through brokers and the transaction costs would be paid to them the transaction costs would be a bank cash flow created bank by both parties whatever the amounts it may not be the same and the debit entry will be capitalized to the investments in the investors books and debited to the liability and the issuers books again it's important it's not between these two parties each may have the iron brokers paying them their own amounts the journal entry you see at the bottom of your screen now is your initial journal entry before the transaction costs so your investment the debits or their credits through the liability is at the fair value your bank amount would be the cash that is exchanged hands and if there's a difference between that fair value and the cash that changed hands you'd have that fair value adjustments on one so we've looked at the initial measurement now the initial recognition and doing the first type a value the next thing now that happens is those transaction costs and to illustrate that there's a set of 40 accounts in front of you now the T accounts in green or the investors T accounts amity accounts in blue or the arrestees accounts the liability side and blue the assets are in green in two separate books what's important to note here now is that transaction costs of 100 Rand if you're looking at the investor in the green he's got it there at a hundred Rand on the debit side because he paid his broker a hundred drained where the liability is the issue of your intervention that's now transaction costs sorry just to correct it the hundred Rand is the amount that the debenture was initially recognized for before the transaction cost so that's them the hundred Rand on the debit side and then on your liability side it's the hundred drained the transaction costs are on the debit side in green for the investor and then you'll see that journal entry is also on the debit side for the person issuing the debentures so the effect day office on the first day of this transaction in your asset account that initial recognition is increased now about the transaction costs there you have your debit being added to your initial debit the difference there with the liability side is your initial recognition of this liabilities on the credit side you have incurred transaction cost paid to your broker that's on the debits so in this case it decreases your initial recognition amount so that deals now with your initial recognition of these instruments are there in the baseless books or the person that has been issuing the debentures the issue is books so you'd have your amount there now at the present value of the future cash flows adjusted with your transaction costs if necessary now you two been ship may be settled in future at an amount which is the same as that poor value initially or it's a premium or it's a discount so they will need to be a movement in this account and we will come to that now but if for example look at the first green sea accounts the amount recognized initially was a hundred grand if there's no transaction cost but it matures added discounts for non-syrian so over the period of the sabine so we will need to decrease this account from the hundred grand down to the nante reigned what happens though of the initial recognition is over the period now there's going to be interest recognized now you interest on it being share as we mentioned is based on the nominal value of the debenture Thoms the nominal interest rate so if it's a 10 percent debenture issued at a par value of 100 grand your interest for that year will be 10 ran to ten percent times the hundred reigned but in your tea accounts that might not be the amount that is initially recognized because we're in accounting recognize it at fair value so for our purposes for the income statement we want to use what we recognized as the value of the asset or the liability to base our interest calculation on for the income statement side of things the profit and loss are so for that we take the balance of our account terms by an effective interest rates and that will tell us then what the interest needs to be for each reporting period their effective interest rate to work that out what you need to do is you need to have a look at what was your debenture initially recognize that that's your present value taking into account transaction costs then you put a new as your future value the amount that it matures for and then you take your cash flow interest over the period based on the nominal value thumbs the nominal rate the cash that will be exchanging ends and then you calculate an interest rate and that interest rate will tell you what your effective interest rate is for accounting purposes to calculate the interest that you're going to be showing and profit and loss so looking now at your journal entry to account for this interest the debit entry day that we referred to for Bank that's your actual cash flow that's a nominal value of the debenture perhaps a hundred rain debenture ten percent so that'll be ten r and the finance income pot the guards to profit and loss that would be based on the balance in your t account that present value adjusted for transaction costs toms by the effective interest rate and then if you have a difference between those two between your effective interest rates and profit and loss and between your cash flow and bank that amount is taken through to the investment accounts and that represents these adjustments to get our opening balance eventually down to what it's going to be settled for at the end of the stub angel so to summarize what we've done so far we did add national recognition where you have your cash flow you then have to recognize it at a present value of all the cash flow is expected over the lease or over the debenture term you have that amount present valued you have capitalized your transaction costs if they are any you have brought your interest into account over the period of the debenture and then finally this debenture will be settled and it will mature and the journal entries now at the bottom of your screen illustrate what will happen with a settling of that debenture at the end of the term and and your general ledger T accounts instead created entry all for a liability that debit entry