Tato Company (Tato), a listed company, purchased a significant item of equipment on 1 July 2018. The list price of the equipment was GH¢12 million, although the supplier always gives Tato a 10% discount on its list prices. Tato was unable to finance the purchase outright and the supplier therefore agreed to accept an arrangement whereby the amount of the payment would be determined by Tato’s share price on 30 June 2020.
At 30 June 2020, under the terms of the agreement, the supplier can choose to receive either:
- cash, equal to the value of 500,000 of Tato’s shares on that date; or
- 540,000 Tato’s shares on 30 June 2020, provided that they cannot be sold for 1 year after that date.
Tato’s share price was GH¢19.80 per share on 1 July 2018 and GH¢20.40 on 30 June 2019.
Required:
Demonstrate with suitable calculations, how the arrangement should be accounted for in Tato Company’s financial statements for the year ended 30 June 2019. (6 marks)
View Solution
This arrangement is a share-based payment with a choice of settlement. As the counterparty (the supplier) has the choice of settlement terms, a compound instrument has been issued and needs to be split into liability and equity components at the grant date.
The equity component is calculated as a residual after measuring the liability component at the grant date:
GH¢m GH¢m
DR Plant (12 x 90%) 10.8
CR Liability (500,000 x GH¢19.80) 9.9
CR Equity (balancing figure) 0.9
The liability component is subsequently revalued to fair value at the year-end:
Fair value of liability at year end (500,000 x GH¢20.40) = GH¢10.2m
GH¢m GH¢m
DR Profit or loss (10.2 – 9.9) 0.3
CR Liability 0.3
Determination of fair value of equipment : 1 mark
Determination of liability component @ initial recognition : 1 mark
Determination of equity component @ initial recognition : 1 mark
Fair value of liability at year end : 1 mark
Charge to Profit or Loss for the year : 2 marks