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    Compound Financial Instruments

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    Jm atlavs
    Compound financial instruments contain both a liability and equity component. They must be accounted for separately, with the liability portion measured first using present value techniques. Any residual amount is allocated to equity. Upon conversion of convertible bonds to shares at maturity, the liability is derecognized and recognized as equity, with no gain or loss. The carrying amount of the converted bonds becomes the value of shares issued.

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    Compound Financial Instruments

    Uploaded by

    Jm atlavs
    620 views3 pages
    Compound financial instruments contain both a liability and equity component. They must be accounted for separately, with the liability portion measured first using present value techniques. Any residual amount is allocated to equity. Upon conversion of convertible bonds to shares at maturity, the liability is derecognized and recognized as equity, with no gain or loss. The carrying amount of the converted bonds becomes the value of shares issued.

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    Compound Fin. Instruments

    Original Title

    29. Compound Financial Instruments

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    Compound financial instruments contain both a liability and equity component. They must be accounted for separately, with the liability portion measured first using present value techniques. Any residual amount is allocated to equity. Upon conversion of convertible bonds to shares at maturity, the liability is derecognized and recognized as equity, with no gain or loss. The carrying amount of the converted bonds becomes the value of shares issued.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    620 views3 pages

    Compound Financial Instruments

    Uploaded by

    Jm atlavs
    Compound financial instruments contain both a liability and equity component. They must be accounted for separately, with the liability portion measured first using present value techniques. Any residual amount is allocated to equity. Upon conversion of convertible bonds to shares at maturity, the liability is derecognized and recognized as equity, with no gain or loss. The carrying amount of the converted bonds becomes the value of shares issued.

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    of 3

    CHAPTER

    BLUE NOTES
    Compound Financial Instruments
    29 S
    L
     PAS 32, paragraph 28, defines a compound financial instrument as “a financial instrument that contains both a
    liability and an equity element from the perspective of the issuer”. (e.g. Bonds payable issued w/ share
    warrants, convertible bonds payable)

    Accounting for compound financial instrument:


    If the financial instrument contains both a liability and an equity component, PAS 32, paragraph 29, mandates that
    such components shall be accounted for separately in accordance with the substance of the contractual arrangement
    and the definition of a financial liability and equity.
    The approach in accounting for a compound financial instrument is to apply the “split accounting”.
    Split accounting:
    The fair value of the liability component is then deducted from the total consideration received from issuing the
    compound financial instrument. The residual amount is allocated to the equity component.
    Type of Compound Financial Accounting Treatment Measurement
    Instrument
    General Compound Financial Liability and Equity Components shall Liability components are measured at
    Instruments be accounted for separately. fair value then the residual amount of
    the issue price shall be allocated to
    the equity component.
    Bonds payable issued with share Liability and Equity Components shall Bonds are measured at FV.
    warrants be accounted for separately. Note: If there is no known FV, PV of
    a. Bonds payable the principal bond liability and PV of
    b. Share warrants the future interest payments using
    effective or market rate shall be used.
    Convertible Bonds Payable Liability and Equity Components shall Bonds are assigned an amount equal
    be accounted for separately. to the market value of the bonds w/o
    a. Bonds payable the conversion privilege.
    b. Conversion privilege Note: If the information above is
    unknown, PV of the principal bond
    liability and PV of the future interest
    payments using effective or market
    rate shall be used.
    Notes:
     Liability and Equity Components shall be accounted for separately – This means that the fair value of the liability component is first
    determined and such is deducted from the total consideration received.
     Note: PAS 32 does not differentiate whether the equity component is detachable or nondetachable. Whether detachable or
    nondetachable, share warrants have a value and therefore shall be accounted for separately.
     The market value of equity components such as share warrants and conversion privilege shall always be ignored in the case of
    compound financial instruments; the residual amount from their issue price will always be the value of equity components.
    Illustration:
    An entity sells 5000 10-year bonds, face value P1000, at 105. Each bond is accompanied by one-warrant that permits
    the bondholder to purchase 20 shares of capital, par P50, at P55 per share, or a total of 100000 shares, 5000 x 20.

    Theory of Accounts Practical Accounting 1


    108 USL Blue Notes Chapter 29 – Compound Financial Instruments

    a. Compute the value of the bonds:

    PV of principal (5000000 x 0.322) 1610000


    PV of interest payments (10% x 5000000 = 500000 x 5.65) 2825000
    PV of the bonds payable 4435000

    b. Compute for the value of the share warrants:

    Issue price of the bonds w/ warrants 5250000


    Less: PV of the bonds 4435000
    Residual amount allocated to warrants 815000

    c. Corresponding journal entries

    Cash 5250000
    Discount on bonds payable 565000
    Bonds payable 5000000
    Share warrants outstanding 815000

    Note: In the illustration, the market value of the bonds ex-warrants is not given therefore the PV approach is used.

    Accounting for the conversion of convertible bonds into share capital:


    Application Guidance 32 of PAS 32 provides that on conversion of a convertible instrument at maturity, the entity
    derecognizes the liability component and recognizes it as equity.
    Notes:
    a. There is no gain or loss on conversion at maturity
    b. The conversion is not considered a significant economic transaction and therefore no gain or loss would be recognized.

    Accordingly, the carrying amount of the bonds payable is the measure of the share capital issued because the
    carrying amount is the “effective price” for the shares issued as a result of the conversion.
    Any cost incurred in connection with the bond conversion shall be deducted from share premium, if any. Otherwise,
    the cost incurred is treated as an expense.
    The carrying amount of the bonds payable is equal to the face value plus accrued interest of the bonds payable is
    equal to the face value plus accrued interest if not paid, plus amortized premium or minus unamortized discount and
    bond issue cost.
    Treatment of “share premium from the conversion privilege” that was recognized at the original issuance of
    the bonds:
     This shall form part of the equity.
     If the bonds are later converted, the “share premium from conversion privlege” should be cancelled because
    this would effectively form part of the total consideration paid for the shares ultimately issued as a result of
    the bond conversion.
    Illustration:
    On December 31, 2010, the statement of financial position showed the following balances:
    Bonds payable – 12% convertible 5000000
    Premium on bonds payable 200000
    Share capital, P40 par, 400000 shares authorized
    and 250000 shares issued 10000000
    Practical Accounting 1 Theory of Accounts
    Chapter 29 – Compound Financial Instruments USL Blue Notes 109

    hare premium – issuance 3000000


    Share premium – conversion privilege 500000

    On the same date the bonds are converted into share capital. The conversion ratio is 20 shares each P1000 bond or a
    total of 100000 shares. Cost incurred in connection with the conversion amounts to P100000. The accrued interest on
    the bonds payable on the date of conversion is P150000 which is paid in cash.

    Bonds payable 5000000


    Premium on bonds payable 200000
    Share premium – conversion privilege 500000
    Total consideration 5700000
    Par value of share capital issued (100000 shares x 40) 4000000
    Share premium 1700000

    Corresponding journal entries:

    Bonds payable 5000000


    Premium on bonds payable 200000
    Share premium – conversion privilege 500000
    Interest expense 150000
    Share capital 4000000
    Share premium – issuance 1700000
    Cash 150000

    Share premium – issuance 100000


    Cash 100000

    Note: Share premium from conversion privilege is canceled upon conversion because this would effectively form part of the total consideration
    received for the shares ultimately issued as a result of conversion.

    Theory of Accounts Practical Accounting 1

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