Addison Manufacturing holds a large portfolio of debt securities as an investment. The fair value of the portfolio is greater than its original cost, even though some securities have decreased in value. Ted Abernathy, the financial vice-president, and Donna Nottebart, the controller, are in the process of classifying this securities portfolio in accordance with the new IFRS standard (IFRS 9) for the first time. Abernathy wants to classify all investments that have increased in value during the period as fair value through net income in order to increase net income this year. He wants to account for all the securities that have decreased in value at amortized cost.
Nottebart disagrees. She tells Abernathy that there are no options now under IFRS. Depending on certain criteria, the debt instrun1ents must be classified into the amortized cost category or the fair value through net income category. Assume the role of the ethical accountant. You work for Addison Manufacturing and Abernathy and Nottebart have asked for your advice regarding the application of IFRS 9.
In your role as the ethical accountant, respond to the following questions assuming that the company has no issues related to accounting mismatches.
(a) Is Nottebart correct in that there are no choices for the classification of debt instruments?
(b) For each of the following types of debt instruments, determine, by referring to the newly issued IFRS 9, if the debt security would be measured at amortized cost or fair value.
1. A debt instrument has a variable rate of interest and matures in 2015. The variable rate is based on the prime bank lending rate and pays 2% above prime. The company has, in the past, bought and sold these bonds and not held them until maturity.
2. A 5% bond, issued by Exnon Inc., is convertible into equity at the holders option. If Addison decides to receive shares rather than cash, the conversion rate to be used is a price of $50 per share of Exnon Inc. Addison will likely request to convert to shares when the share price of Exnon is over $55 per share or more.
3. A corporate bond pays interest that is linked to an inflation index. The company expects to hold on to this bond until it matures.
4. A perpetual bond (meaning it has no maturity date), issued by Resource Inc., can be called at any point by the issuer. If the bond is called, Addison will receive the face value of the bond plus any accrued interest. In addition, interest can only be paid on the bond if Resource Inc. meets certain solvency tests, before and after the payment of the interest. The company plans to hold this debt investment in perpetuity.