Question

Wang Corporation purchased $100,000 of Hales Inc. 6% bonds at par with the intent and ability to hold the bonds until they matured in 2017, so Wang classifies its investment as held to maturity. Unfortunately, a combination of problems at Hales and in the debt market caused the fair value of the Hales investment to decline to $70,000 during 2013. Wang calculates that, of the $30,000 drop in fair value, $10,000 of it relates to credit losses and $20,000 relates to non-credit losses. If Wang accounts for the Hales bonds under IFRS, before-tax net income for 2013 will be reduced by:

A) $0.
B) $10,000.
C) $20,000.
D) $30,000.

Answer 1

The correct answer is option B. Only credit losses on held-to-maturity investments are recognized in profit and loss under IFRS. Since Wang Corporation's investment in Hales Inc. bonds experienced a credit loss of $10,000, this is the amount by which Wang's before-tax net income for 2013 will be reduced.

Step-by-step explanation:

Under International Financial Reporting Standards (IFRS), investments classified as held to maturity are accounted for at amortized cost, not fair value, unless they are deemed to be impaired. An impairment occurs when the carrying amount of an asset exceeds its recoverable amount.

In the scenario presented, Wang Corporation purchased Hales Inc. bonds with an intent to hold them to maturity. The fair value decline of the bonds is due to two factors: $10,000 related to credit losses and $20,000 related to non-credit losses. IFRS requires that credit losses on such financial assets be recognized in profit and loss, affecting before-tax net income, while non-credit losses are not immediately recognized unless the credit risk has increased significantly or the assets are credit-impaired.

Since only $10,000 of the fair value decline is due to credit losses, this is the amount that will reduce the Wang Corporation's before-tax net income for 2013. Hence, the correct answer is B) $10,000.