Wallaby Ltd and Dingo Ltd enter into a contractual obligation to pay cash of $500 to Bandicoot Ltd in 5 years time. Wallaby Ltd has a AA credit rating and can borrow at 6%. Dingo Ltd has a BBB credit rating and can borrow at 12%. At initial recognition, the fair value of the liability of each entity must reflect the credit standing of that entity.

Required

1. Determine the fair values of the contractual obligations of Wallaby Ltd and Dingo Ltd to Bandicoot Ltd on initial recognition.

2. Assume Wallaby Ltds credit rating decreases to AA by the end of the first year and its borrowing rate changes to 7%, while Dingo Ltds credit rating improves to BB and its borrowing rate changes to 11%. Determine the fair value measurements of the contractual obligations after based on the new credit ratings. Does a gain or loss on re-measurement of a contractual obligation arise when the credit rating worsens?