Allgo Mining Ltd needs to raise $1,000,000 to finance the acquisition of a new mining equipment. It approached an investment bank that proposed the following two alternatives:

(a) the issue of 8%, cumulative preference shares for $1,000,000 with a fixed redemption date 5 years from the date of issue (8% cumulative preference shares), or 

(b) the issue of 10%, non-cumulative, preference shares for $1,000,000, redeemable at the option of the issuer (10% non-cumulative preference shares). 

The preference share issue is planned for 2020. The accountant prepared an abridged projected statement of financial position for Allgo Mining  Ltd s at 31 December 2020, based on the company's master budget. The projected statement of financial position excludes the effects of the proposed preference share issue or the investment in the new mining equipment.

Extract from Projected statement of financial position of Allgo Mining Ltd as at December 2020

Total Assets 5,000,000

 

Liabilities 3,000,000

          Equity 2,000,000

Additional information

•   Allgo Mining Ltd estimates profit before interest and tax (EBIT) as $420,000. This estimate is based on prior years' performance, adjusted for the effects of the additional mining equipment. 

•   Interest expense in relation to a bank loan included in 'Liabilities' = $100,000

•   Allgo Mining Ltd's bank loan includes a debt covenant which specifies a maximum leverage ratio (total liabilities/total assets) of 60%. 

•   The company has investigated alternative sources of funding and found that most lenders require it to have maintained interest coverage (EBIT/Interest expense) greater than 3.0.

•   Management receives a bonus of 2% of profit before tax, provided the return on investment (EBIT/total assets) exceeds 12%.

How should the 8% cumulative preference shares be classified in the financial statements in accordance with AASB 132/IAS 32?

Answer rating: 100% (QA)

According to AASB 132IAS 32 financial instruments should be classified b... View the full answer