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ABC Plc is a company listed on the Stock Exchange

Scenario 2
Financial Instruments
ABC Plc is a company listed on the Stock Exchange. During a management meeting, the CEO expressed concern about ABC’s financial instruments and instructed the financial directors to provide information about them.

ABC Plc purchased a debt instrument on January 1, 2023, for its fair value of $6,000. The instrument has a principal amount of $7,500 and carries a fixed interest rate of 5%, which is paid annually. It is set to mature on December 31, 2027, and the effective interest rate is 8%.
On January 1, 2024, ABC Plc has a portfolio of trade receivables totaling $480 million, consisting of a large number of small clients. The company applies IFRS 9 and uses a provision matrix to determine the expected credit losses for this portfolio. The provision matrix is based on the company's historically observed default rates, adjusted for forward-looking estimates. These historically observed default rates are updated at each reporting date. At 1st Jan 2024, ABC Plc estimates the following provision matrix. Expected default rate Gross carrying amount.
‘000’ Credit loss allowance.
(Default rate x gross carrying amount) ‘000’
Current 0.3% 240000 720
1 to 30 days overdue 1.6% 120000 1920
31 to 60 days overdue 3.6% 64000 2304
61 to 90 days overdue 6.6% 40000 2640
More than 90 days overdue 10.6% 16000 1696
480000 9280

On December 31, 2024, ABC Plc has a portfolio of trade receivables amounting to $544 million. The company has revised its forward-looking estimates, determining that the general economic conditions are less favorable than previously anticipated. Below is the partly completed provision matrix.

Expected default rate   Gross carrying amount ‘000’

Current 0.5% 256000
1 to 30 days overdue 1.8% 128000
31 to 60 days overdue 3.8% 80000
61 to 90 days overdue 7% 56000
More than 90 days overdue 11% 24000
544000

   You are required to:

A. How should ABC Plc account for the debt instrument over its five-year term?
(2 marks)
B. Evaluate the provision matrix for ABC Plc at 31st Dec 2024 and show the journal entries to record the credit loss allowance.
. (2 marks)
Scenario ‘2’ Total =3 Marks

Full Answer Section

2 marks)

B. Evaluate the provision matrix for ABC Plc at 31st Dec 2024 and show the journal entries to record the credit loss allowance.

First, let's complete the provision matrix at 31st December 2024:

Expected default rate	Gross carrying amount ‘000’	Credit loss allowance ‘000’ (Default rate x gross carrying amount)
Current	0.5%	256,000
1 to 30 days overdue	1.8%	128,000
31 to 60 days overdue	3.8%	80,000
61 to 90 days overdue	7%	56,000
More than 90 days overdue	11%	24,000
		544,000

The total credit loss allowance at 31st December 2024 is $13,184,000.

Now, let's determine the movement in the credit loss allowance during 2024. The credit loss allowance at 1st January 2024 was $9,280,000. The credit loss allowance at 31st December 2024 is $13,184,000.

The increase in the credit loss allowance during 2024 is:

$13,184,000 - $9,280,000 = $3, 904, 000$

The journal entry to record the increase in the credit loss allowance at 31st December 2024 would be:

Account	Debit	Credit
Credit Loss Expense	$3,904,000
Allowance for Expected Credit Losses		$3,904,000
To record the increase in credit loss allowance

Sample Answer

A. How should ABC Plc account for the debt instrument over its five-year term?

ABC Plc should account for the debt instrument as an amortized cost financial asset. This is because the business model for holding this debt instrument is likely to collect contractual cash flows (principal and interest). The instrument has a fixed interest rate and a defined maturity date.

Over the five-year term, ABC Plc will:

Initially recognize the debt instrument at its fair value of $6,000.
Recognize interest revenue using the effective interest rate of 8%, not the stated coupon rate of 5%. This involves amortizing the difference between the fair value and the principal amount ($7,500 - $6,000 = $1,500) over the life of the instrument.
Recognize cash received from the annual interest payments (5% of $7,500 = $375).
Increase the carrying amount of the debt instrument each year by the effective interest revenue and decrease it by the cash received. By the maturity date, the carrying amount will equal the principal amount of $7,500.