October 20X1, Little Raven plc issued 50,000 debentures, with a par value of £100 each, to investors at £80 each.The debentures are redeemable at par on 30 September 20X6 and have a coupon rate of 6%, which was significantly below the market rate of interest for such debentures issued at par. In accounting for these debentures to date, Little Raven plc has simply accounted for the cash flows involved, namely:

● On issue: Debenture ‘liability’ included in the balance sheet at £4,000,000.

● Income statements: Interest charged in years ended 30 September 20X2, 20X3 and 20X4

(published accounts) and 30 September 20X5 (draft accounts) – £300,000 each year (being 6% on

£5,000,000).

The new finance director, who sees the likelihood that further similar debenture issues will be made, considers that the accounting policy adopted to date is not appropriate. He has asked you to suggest a more appropriate treatment.

Little Raven plc intends to acquire subsidiaries in 20X6.

Income statements for the years ended 30 September 20X4 and 20X5 are as follows:

Required:

(a) Outline the considerations involved in deciding how to account for the issue, the interest cost and the carrying value in respect of debenture issues such as that made by Little Raven plc.
Consider the alternative treatments in respect of the income statement and refer briefly to the appropriate balance sheet disclosures for the debentures. Conclude in terms of the requirements of IAS 32 (on accounting for financial instruments) in this regard.

(b) Detail an alternative set of entries in the books of Little Raven plc for the issue of the debentures and subsequently; under this alternative the discount on the issue should be dealt with under the requirements of IAS 32. The constant rate of interest for the allocation of interest cost is given to you as 11.476%. Draw up a revised income statement for the year ended 30 September 20X5 – together with comparatives – taking account of the alternative accounting treatment.

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Income statements for the years ended 30 September 20X4 and 20X5 are as follows: Yle 30 Sept 20X5 (Draft) Yle 30 Sept 20X4 (Actual) 000 000 Turnover 6,700 6,300 Cost of sales (3,025) (2,900) Gross profit 3,675 3,400 Overheads (600) (550) Interest payable - debenture (300) (300) - others (75) (50) Profit for the financial year 2,700 2,500 Retained profits brought forward 4,300 1,800 Retained profit carried forward 7,000 4,300