Core 1 — Integrated Problem 2

Solution

The following solution is a “best” response, demonstrating a level much higher than
competent. However, there may be additional acceptable and reasonable points that are
not reflected in this response.

In addition, candidates are not expected to prepare a response of this level given the
time constraints involved and, if applicable, page limits provided.

Memo

To: Owen Starr

From: CPA
Subject: Financial instruments

Assessment Opportunity #1

The candidate discusses the appropriate accounting treatment of the note receivable.

The candidate demonstrates competence in Financial Reporting.

CPA Map Competencies:

1.2.1 Develops or evaluates appropriate accounting policies and procedures (Core –

Level A)
1.2.2 Evaluates treatment for routine transactions (Core – Level A)

Under IFRS, financial instruments are covered under two sections: IAS 32, which
primarily discusses the definition and presentation of financial instruments, and IFRS 9,
which primarily discusses the classification and measurement of financial instruments.

Note receivable

IFRS

Classification
Doyle Games (Doyle) has received equipment and, in exchange, has provided All Starr
with a three-year note. As such, All Starr has a contractual right in the form of the note
Chartered Professional Accountants of Canada, CPA Canada, CPA
are trademarks and/or certification marks of the Chartered Professional Accountants of Canada.
© 2023, Chartered Professional Accountants of Canada. All Rights Reserved.

Les désignations « Comptables professionnels agréés du Canada », « CPA Canada » et « CPA »

sont des marques de commerce ou de certification de Comptables professionnels agréés du Canada.
© 2023 Comptables professionnels agréés du Canada. Tous droits réservés.
2022-07-12
Core 1 — Integrated Problem 2 Solution

receivable, and Doyle has a financial obligation to make the payment in three years’
time. This meets the definition of a financial asset per IAS 32.11.

Measurement
This is essentially a loan receivable, and would be classified as a financial asset. The
receivable should be recognized upon issuance (January) at fair value with subsequent
measurement at amortized cost as per IFRS 9 paragraph 4.1.2:

A financial asset shall be measured at amortised cost if both of the following

conditions are met:

(a) the financial asset is held within a business model whose objective is to hold
financial assets in order to collect contractual cash flows and

(b) the contractual terms of the financial asset give rise on specified dates to
cash flows that are solely payments of principal and interest on the principal
amount outstanding.

Fair value is not provided in the case. Given that All Starr is willing to wait three years
for an $80,000 payment, it is reasonable to assume that they would accept a cash
payment today at a lower amount. As such, the transaction must be valued at its
present value on the balance sheet using All Starr’s 8% effective rate of interest
(paragraph 5.4 of IFRS 9). It is also reasonable to assume that the present value of the
future payment, calculated using an 8% discount rate, would approximate the fair value
of the note receivable today.

Interest must also be accrued annually at 8%, and this effectively amortizes the note
receivable balance to the date of payment. We will need to record interest to bring the
balance up to amortized cost as at the balance sheet date. See the Exhibit for the
adjusting journal entries required.

ASPE

Classification
The definition of a financial asset in ASPE Section 3856 Financial Instruments is
converged with that of IFRS, so the note receivable meets the definition of a financial
asset under ASPE as well. A financial asset includes notes receivable (as noted in
ASPE 3856.02) and is a contractual right to receive cash (as per ASPE 3856.05(h)(ii)).

Measurement
The receivable should be measured at its fair value when initially acquired. The note
receivable is issued with a non-market rate of interest; as such, ASPE 3856.A8 states
that the fair value is not equal to the cash consideration. The fair value can be estimated
as the present value of all future cash receipts discounted using All Starr’s 8% rate of
interest, as it is under IFRS.

2/9
Core 1 — Integrated Problem 2 Solution

The note receivable will be subsequently measured at amortized cost at each balance
sheet date, as per ASPE 3856.11(a)(iv). ASPE provides an option to choose either the
effective interest rate method, as described under IFRS above, or the straight-line
interest rate method. Since All Starr is planning to go public, I recommend using the
effective interest rate method to reduce the number of changes when transitioning from
ASPE to IFRS. The adjusting journal entries required under ASPE will be the same as
under IFRS.

Assessment Opportunity #2

The candidate analyzes the assertion-level risks for the note receivable accounting
issue and designs procedures to address the risks.

The candidate demonstrates competence in Assurance.

CPA Map Competencies:

4.3.5 Assesses the risks of the project, or, for audit engagements, assesses the risks of
material misstatement at the financial statement level and at the assertion level for
classes of transactions, account balances, and disclosures (Core – Level B)
4.3.6 Develops appropriate procedures, including Audit Data Analytics (ADA), based on
the identified risk of material misstatement (Core – Level B)

Audit

Risk
There is a risk that the amount may not be received, especially since repayment of the
note receivable is contingent on a grant from the government. Given the upcoming initial
public offering, All Starr does have a bias to overstate the receivable, which results in a
high risk of material misstatement for this account.

Account and Assertion

Note receivable: existence

Procedures
In order to address this risk, the auditors could:
• Send a confirmation to Doyle to confirm the amount of the note receivable and the
related terms.
• Inspect the invoice for the equipment sold to Doyle and agree the invoice to the
shipping documents to ensure the sale was entered into during this period.

3/9
Core 1 — Integrated Problem 2 Solution

Risk
Given the upcoming initial public offering, All Starr does have a bias to overstate the
receivable, which results in a high risk of material misstatement for this account.

Account and Assertion

Note receivable: accuracy, valuation, and allocation

Procedures
In order to address this risk, the auditors could:
• Recalculate the amortized cost to ensure the note receivable is recorded at the
correct amount.
• Inspect the invoice for the equipment sold to Doyle and confirm the selling price of
the equipment to confirm the value of the note receivable.

Assessment Opportunity #3

The candidate discusses the appropriate accounting treatment of the warranty.

The candidate demonstrates competence in Financial Reporting.

CPA Map Competencies:

1.2.1 Develops or evaluates appropriate accounting policies and procedures (Core –

Level A)
1.2.2 Analyzes treatment for routine transactions (Core – Level A)

Warranty

IFRS

Classification
Most warranty obligations are not financial liabilities because the outflow associated
with them is the delivery of goods and services rather than a contractual obligation to
pay cash or another financial asset (IAS 32.11). All Starr will repair the faulty game
cartridge or supply a new one to settle the warranty. Therefore, the warranty obligation
is not considered a financial instrument under IFRS.

ASPE

Classification
The definition of a financial liability under ASPE 3856 is the same as that under IFRS;
as a result, the conclusion as to whether the warranty obligation is a financial instrument
is the same under both standards.

4/9
Core 1 — Integrated Problem 2 Solution

Based on the information provided on the treatment of the warranty obligation, no

adjusting entry is proposed at this time.

Assessment Opportunity #4

The candidate analyzes the assertion-level risks for the warranty issue and designs
procedures to address the risks.

The candidate demonstrates competence in Assurance.

CPA Map Competencies:

4.3.5 Assesses the risks of the project, or, for audit engagements, assesses the risks of
material misstatement at the financial statement level and at the assertion level for
classes of transactions, account balances, and disclosures (Core – Level B)
4.3.6 Develops appropriate procedures, including Audit Data Analytics (ADA), based on
the identified risk of material misstatement (Core – Level B)

Audit

Risk
There is a natural bias for All Starr to understate liabilities, especially considering a
potential initial public offering. The inherent bias and the professional judgment required
to estimate the warranty liability results in a high risk of material misstatement for this
account.

Account and Assertion

Warranty liability: completeness

Procedures
In order to address this risk, the auditors could:
• Compare the prior-year provision with the current year’s actual expenditure on
warranty claims to assess whether the previous period’s provision was reasonable.
• Compare the current-year warranty provision with prior years’ provisions and discuss
any fluctuations with the person responsible for preparing the estimated provision, to
assess whether the provision is valued properly.
• Review significant contracts and a sample of sales orders to determine whether any
additional terms of the warranty should be considered obligations of the company.

5/9
Core 1 — Integrated Problem 2 Solution

Assessment Opportunity #5

The candidate discusses the appropriate accounting treatment of the securities.

The candidate demonstrates competence in Financial Reporting.

CPA Map Competencies:

1.2.1 Develops or evaluates appropriate accounting policies and procedures (Core –

Level A)
1.2.2 Evaluates treatment for routine transactions (Core – Level A)

Securities

IFRS

Classification
The shares held in Pacific Loans and Savings (Pacific) are financial instruments
because they represent equity instruments of another entity (IAS 32.11).

Measurement
Per IFRS 9.4.1.4, “A financial asset shall be measured at fair value through profit or loss
unless it is measured at amortised cost in accordance with paragraph 4.1.2 or at fair
value through other comprehensive income in accordance with paragraph 4.1.2A.”

As management’s intention is to hold these shares for short-term capital appreciation,

the shares would not meet the criteria to be measured at amortized cost or at fair value
through other comprehensive income (FVOCI). This would mean that the shares would
be measured at fair value through profit or loss (FVPL) unless the election to classify
the shares at FVOCI is available.

Per paragraph IFRS 9.4.1.4, “an entity may make an irrevocable election at initial
recognition for particular investments in equity instruments that would otherwise be
measured at FVPL to present subsequent changes in FVOCI.” The election is not
available if the shares are held for trading, which IFRS 9 Appendix A defines as:

A financial asset or financial liability that:

(a) is acquired or incurred principally for the purpose of selling or repurchasing it

in the near term;

(b) on initial recognition is part of a portfolio of identified financial instruments

that are managed together and for which there is evidence of a recent actual
pattern of short-term profit-taking; or

6/9
Core 1 — Integrated Problem 2 Solution

(c) is a derivative (except for a derivative that is a financial guarantee contract or

a designated and effective hedging instrument).

As management acquired the shares with the intention of selling them in the short term
if the price increased, they would meet the first criterion and would be considered held
for trading. Criteria (b) and (c) would not be met.

Therefore, the election to measure at FVOCI is not available and the shares must be
measured at FVPL, with changes in fair value being reported in net income. The shares
were initially recorded correctly at $33,000 and the adjusting journal entry is provided in
the Exhibit.

ASPE

Classification
As under IFRS, the shares held in Pacific are financial instruments because they
represent equity instruments of another enterprise (ASPE 3856.05(h)(iv)).

Measurement
Per ASPE 3856.07, a financial instrument shall be measured at its fair value when
acquired, as it is under IFRS. Therefore, the shares were initially recorded correctly at
$33,000. Under ASPE, the shares will be subsequently measured at fair value because
they are investments quoted in an active market (ASPE 3856.12(a)). ASPE 3856.12
also states that changes in fair value will be recognized in net income in the period
incurred. Other comprehensive income does not exist under ASPE, so unrealized gains
and losses will be reported in net income.

The adjusting journal entry required under ASPE will be the same as under IFRS.

7/9
Core 1 — Integrated Problem 2 Solution

Assessment Opportunity #6

The candidate analyzes the assertion-level risks for the securities accounting issue and
designs procedures to address the risks.

The candidate demonstrates competence in Assurance.

CPA Map Competencies:

4.3.5 Assesses the risks of the project, or, for audit engagements, assesses the risks of
material misstatement at the financial statement level and at the assertion level for
classes of transactions, account balances, and disclosures (Core – Level B)
4.3.6 Develops appropriate procedures, including Audit Data Analytics (ADA), based on
the identified risk of material misstatement (Core – Level B)

Audit

Risk
Pacific is a publicly traded company, so the auditors will be concerned with whether the
shares have been recorded at the correct price because the price of the shares
fluctuates. However, as the shares are traded on the Toronto Stock Exchange, it will be
easy to obtain fair market value each period.

Account and Assertion

Investment — Pacific — FVPL: accuracy, valuation, and allocation

Procedures
In order to address this risk, the auditors could:
• Confirm the fair market value of the shares by checking the quoted stock market
price at the balance sheet date and recalculating the loss.
• Inspect the publicly available annual financial statements of Pacific to determine
whether there are any significant issues that may indicate a permanent impairment
in stock value given that the price of the shares has declined.

Risk
Given that the shares were purchased this year, the auditors will also be concerned with
whether All Starr purchased and continues to hold the 1,500 shares of Pacific.

Account and Assertion

Investment — Pacific — FVPL: existence

8/9
Core 1 — Integrated Problem 2 Solution

Procedures
In order to address this risk, the auditors could inspect share certificates to confirm that
All Starr holds title to the shares.

9/9