Background

Green Tower Bhd (GTB) is a conglomerate investment company established in Malaysia since 1990. To date, GTB has 10 subsidiaries with diversified industries specialising in construction and property development. The year 2020 certainly did not take off with a good start for the industry, the nation and worldwide. Since February 2020, countries around the globe face the unprecedented economic, health, and financial impact of the COVID-19 global crisis. This event almost certainly bring on new measures, policies and regulations with which GTB must comply to support recovery and future growth of the industry in Malaysia.

Heading new challenge

In 2020, GTB took measures to increase its resilience against market uncertainties and made strategic initiatives to maximise on future opportunities. GTB has been preparing itself to further widen its horizons. The board of GTB has identified a potential acquisition target, Indah Sdn Bhd, located in Alor Setar, Kedah. Indah Sdn Bhd is an unlisted, family-run company that owns and operates commercial buildings since 2010. After several months of discussion and negotiations, the owners of Indah Sdn Bhd expressed interest to sell their business and hope to raise RM60 million for the equity plus another RM18 million to pay off all borrowings. The company reported a total assets value of RM70 million in its recent 2019's statement of financial position. Most of its assets were in cash and equivalents except for property, plant and equipment which had a carrying value of RM50 million as at December 2019. Based on an expert opinion, the value of Indah Sdn Bhd's property, plant and equipment could reach up to RM65 million for its land and new buildings are in the centre of Alor Setar township. Careful examination of Indah's book indicated that its current assets included receivables amounted to RM3 million from Swan Sdn Bhd which is undergoing liquidation process. None of this amount can be salvaged. Indah Sdn Bhd has 2 million shares outstanding.

GTB decided to upscale Indah Sdn Bhd to support GTB's new image of eco-friendly building and green sustainable construction. All renovation works will be completed before the launching of the new upgraded building by the end of 2021. To properly determine the fair value of Indah Sdn Bhd, the chief financial controller of GTB prepared a three-year cashflow forecast for Indah Sdn Bhd. He also provided the probability estimates to account for conceivable business risks related to the amount of cashflow attained for the given years. The probability is expected to remain constant at 80% after year 3. The following table presents the relevant cash flow and probability estimates regarding Indah Sdn Bhd:

All revenues and expenses are expected to grow at the historical rates. Net cash flows beyond year 3 is expected to sustain indefinitely. The estimated weighted average cost of capital for GTB is 10% although a similar non-listed company as Indah Sdn Bhd is expected to incur additional premium of 2% for added risks and volatility. The effective tax rate applied to Indah Sdn Bhd remains unchanged at 24% for all years. The following table presents the present value factor for single sum and annuity.

New bond

As part of its sustainable strategy, GTB launch a mega project, Safe Paint, utilising green technology in the production of construction materials for residential and commercial buildings. Safe Paint uses organic and eco-friendly paint mixture that can naturally break down without releasing toxin to the earth. On 1 January 2020, the board of directors of GTB approved to invest in 10% fixed rate, RM5 million, 5-year CCC bond at par. Due to Covid-19 pandemic, Malaysia's economies contracted sharply triggered by slowdown of business activities during movement control orders. As a result, all businesses were severely affected, and the bond's credit rating weakened due to change on non- performance risk and lack of catalyst to boost the business. The company estimated that the risk of default is low and the probability of default within 12-months period is 0.5%. However, if the covid-19 pandemic persists for another two years, the company estimated no further interest will be received and only 80 % of the investment will be repaid

Hedging strategy

GTB uses aluminum in the production of its building materials. Due to global economic uncertainties, the management is worried that the fluctuation on aluminum's prices would adversely affect the company's risk and financial performance. Therefore, the management adopted a risk management policy, which is to hedge the commodity price risk arising from shortage of supply and rising price of aluminum. GTB anticipated that it needs to purchase 20,000 kg of aluminum in March 2021 for production in quarter 1, 2021. Hence, on 1 April 2020 GTB entered into aluminum forward contract, which will expire on 30 September 2020. The contract is designated as a cash flow hedge with a notional amount of 20,000 kg and the terms of the contract gave GTB the right and the obligation to purchase aluminum at a price of RM40 per kg.

On 30 September 2020, GTB purchased 20,000 kg aluminum inventory at the spot price and settled the forward contract. Later, on 30 December 2020 GTB made cash sales on building components containing the aluminum purchased for RM4 million. The cost of finished goods inventory was RM1 million. Based on recent information, GTB has an average cost of capital of 12% per annum. GTB prepares financial statements on 30 June and 31 December. The prices of aluminum during the hedging period were as follows:

REQUIRED: (Round up all final answers to the nearest RM)

(c) Calculate the expected credit loss and carrying amount of the bond to be recognized at 31 December 2020.

(d) Prepare all journal entries regarding the cash flow hedges for the year 2020. Show all workings. If no entry is needed, write "no journal entry".

(e) Prepare a partial Statement of Financial Position for Green Tower Bhd for the period ended 30 June 2020 to reflect transactions related to cash flow hedges.

(f) Prepare a partial Statement of Profit and Loss and Other Comprehensive Income for Green Tower Bhd. for the period ended 31 December 2020 to reflect transactions in (d).

(g) Discuss the main risks related to financial instruments.

Year 0 Year 1 Year 2 Year 3 Total revenues (RM) Total fixed annual costs (RM) Total variable cost (RM) Renovation costs (RM) Probability of attainment 60,000,000 1,000,000 3,000,000 75,000,000 1,300,000 4,500,000 94,000,000 1,550,000 6,000,000 50,000,000 95% 90% 80% Period 1 2 Present Value Table Single sum 10% 12% 0.909 0.893 0.826 0.797 0.751 0.712 0.683 0.636 0.621 0.567 0.564 0.507 1% 0.990 0.980 0.971 0.961 0.951 0.942 Ordinary annuity 10% 12% 0.909 0.893 1.736 1.690 2.487 2.402 3.170 3.037 3.791 3.605 4.355 4.111 m+ 4 5 6 1 April 2020 RM40 30 April 2020 RM38 30 June 2020 RM43 30 September 2020 RM47 Spot price per kg Year 0 Year 1 Year 2 Year 3 Total revenues (RM) Total fixed annual costs (RM) Total variable cost (RM) Renovation costs (RM) Probability of attainment 60,000,000 1,000,000 3,000,000 75,000,000 1,300,000 4,500,000 94,000,000 1,550,000 6,000,000 50,000,000 95% 90% 80% Period 1 2 Present Value Table Single sum 10% 12% 0.909 0.893 0.826 0.797 0.751 0.712 0.683 0.636 0.621 0.567 0.564 0.507 1% 0.990 0.980 0.971 0.961 0.951 0.942 Ordinary annuity 10% 12% 0.909 0.893 1.736 1.690 2.487 2.402 3.170 3.037 3.791 3.605 4.355 4.111 m+ 4 5 6 1 April 2020 RM40 30 April 2020 RM38 30 June 2020 RM43 30 September 2020 RM47 Spot price per kg