Harmandeep Ltd. is a private company in the pharmaceutical industry. It has been preparing its financial statements in accordance with ASPE. Since it has plans to go public in the next 3 to 5 years, it is considering changing to IFRSs for the current year. It wishes to adopt policies that will maximize the return on shareholders' equity. Based on the draft financial statements prepared in accordance with ASPE, its net income for Year 5 is $400,000, and its shareholders' equity at December 31, Year 5 is $3,500,000.
Harmandeep has engaged you to reconcile net income and shareholders' equity from ASPE to IFRSs. You have identified the following five areas for which IFRSs differs from ASPE:
1. Impaired loans-original versus market rate of interest
2. Interest costs-capitalize versus expense
3. Actuarial gains/losses-recognize immediately or defer and amortize
4. Compound financial instrument-debt versus equity components
5. Income taxes-future income tax method or taxes payable method
Harmandeep provides the following information with respect to each of these accounting differences.
One of Harmandeep's debtors is in financial difficulty and defaulted on its loan payment during the year. The outstanding balance on this loan receivable at the end of Year 5 was $220,000. Harmandeep agreed to accept five annual payments of $50,000 with the first payment due at December 31, Year 6, as a full settlement of the loan. The original interest rate on the loan was 8%. The market rate of interest for this type of loan is 6%. No adjustment has been made for the impairment of the loan receivable.
Harmandeep arranged a loan of $800,000 to finance the construction of a warehouse. $400,000 was borrowed on March 1, Year 5, and another $400,000 was borrowed on October 1, Year 5. The loan is repayable over 5 years with an interest rate of 6%, with the first payment due on September 30, Year 6. The warehouse was nearly complete at the end of Year 5. No interest has been accrued on the loan at the end of Year 5.
Harmandeep instituted a defined benefit pension plan in Year 3. The first actuarial evaluation, which was done as at June 30, Year 5, indicated an actuarial gain of $150,000. The expected average remaining service life of the employee workforce was 15 years at the time of the actuarial evaluation. The actuarial gain has not yet been recognized in the preliminary financial statements.
Compound Financial Instrument
Harmandeep issued bonds for proceeds of $1,000,000 on December 31, Year 5. The bonds are convertible into common shares at any time within the next five years. The bonds would have been worth only for $950,000 if they did not have the con version feature. The proceeds on the bonds have been recognized as long-term debt in the preliminary financial statements.
Harmandeep's income tax rate has been and is expected to continue at 40%. Assume that any adjustments to accounting income for the above items are fully deductible or taxable for tax purposes. The preliminary financial statements reflect the tax payable method of accounting for income taxes. If the future income tax method were adopted, future tax liabilities should be set up for $300,000 at the end of Year 4 and $340,000 at the end of Year 5.
Prepare a schedule to convert net income and total shareholders' equity from the preliminary financial statements amounts to amounts under ASPE and IFRSs.
Where accounting choices exist, choose policies that minimize return on total shareholders' equity under ASPE and maximize return on total shareholders' equity under IFRSs.