Chapter 7 EQUITY INSTRUMENT= A-L
COMPOUND FINANCIAL INSTRUMENT -any contract that evidences a residual
interest in the assets of an entity after deducting all
Financial Instrument (PAS 32, p11) the liabilities
- any contract that gives rise to both a -include:
financial asset of one entity and a financial liability Ordinary Share Capital
OR equity instrument of another entity Preference Share Capital
Warrants or Option
CHARACTERISTICS OF A FINANCIAL
INSTRUMENT COMPOUND FINANCIAL INSTRUMENT (PAS 32,
a. There must be a contract P28)
b. Two parties to the contract -a financial instrument that contains both a
c. Contract shall give rise to a financial asset liability and an equity element from the perspective
to one party and a financial liability or equity of the issuer
to another party. -meets the definition of a financial liability,
financial instrument and of an equity instrument
EXAMPLES OF FINANCIAL INSTRUMENT
ASSET LIAB/EQUITY Examples:
Cash in form of Holder or (Liab) Issuing a. Bonds payable(L) issued with share
notes and coins bearer Government warrants(E)
Cash in form of (Liab) Drawer or b. Convertible bonds payable(L)
Payee
checks Issuer - Convertible privilege(E)
(Liab) Depository
Cash in Bank Depositor
Bank ACCOUNTING FOR COMPOUND INSTRUMENT
(Liab) Customer or
Trade Accounts Seller (A/R) Contains both a liability and an equity
Buyer (A/P)
component – shall be accounted for
Lender or
(Liab) Borrower or separately
Notes and Creditor (N/R
Debtor (N/P or
Loans or Loans
Loans Payable) Split Accounting – approach in accounting for
Rec.)
Debt Securities Investor (Liab) Issuer compound financial interest
Equity
Investor (Equity) Issuer
Securities Total Proceeds/Issue Price (w/ warrants) xx
PV of Liability w/o equity (w/o warrants_ xx
FINANCIAL LIABILITY- any liability that is a Equity Component (residual amount) xx
contractual obligation: WARRANTS
a. To deliver cash or other financial asset
to another entity BONDS PAYABLE ISSUED WITH SHARE
b. To exchange financial instruments with WARRANTS
another entity under conditions that are
potentially unfavorable (economic Bondholders are given the RIGHT TO:
outflow) acquire shares of the issuing entity at a
specified price at some future time
Ex: Trade accounts payable, Notes Payable, Loans
Payable, Bonds Payable -two securities sold: bonds and share
warrants (detachable/nondetachable)
NONFINANCIAL LIABILITIES
1. Deferred revenue and warranty Example: (with Given Bonds Ex- warrants)
obligations – the outflow is the delivery of ‒ Issued 5,000 10-yr bonds- Face Amount
goods & services rather than contractual P1000 per bond, at 105.
obligation to pay cash
2. Income tax payable – imposed by the law ‒ 1 bond=1warrant, 20 equity shares par
and noncontractual P50, at P55 per share. (5,000x20=100,000
3. Constructive Obligation – the obligations shares)
do not arise from contracts ‒ Bond ex-warrant at issuance is 98.
1. Issuance of the bonds
Cash (5Mx105) 5,250,000** CONVERTIBLE BONDS
Discount on BP 100,000 Convertible Bonds – give the holders the right to
BP (100,000 shares x 50) 5,000,000 convert their bondholdings into share capital or
Share Warrants outstanding 350,000* other securities
-becomes less attractive as time goes by
Issue Price of Bonds w/ Warrants -when issued at PREMIUM/ DISCOUNT,
MV of Bonds ex Warrants (5Mx98) 5,250,000** amortization is up to maturity date
(4,900,000)
Residual Amount Allocated to Warrants 350,000* Accounting PROBLEMS rise when:
1. Convertible bonds are Originally issued
2. Exercise of 60% of the warrants 2. Convertible bonds are converted
Cash (60,000 sharesx55par) 3,300,000
Share Warrants Outstanding 210,000 1, ORIGINAL ISSUANCE
(350,000x60%)
- partly liability (bonds payable) and partly equity
Share Capital (60,000 shares x 50) 3,000,000
(conversion privilege)
Share Premium 510,000
Allocation of Issue Price
3. To record the expiration of remaining
Bonds = Market Value of Bonds w/o
warrants
Share Warrants Outstanding(350,000-210,000)
Conversion privilege
140,000
Share Premium- Unexercised SW Conversion privilege = Residual Amount or
140,000
remainder of the issue price
(MV of Bonds Ex-warrants UNKNOWN)
Bonds=PV of Principal + PV of Future Interest Payments If the MV w/o Conversion privilege is NOT given:
PV of Principal Bond Liability (EIR) xx
‒ Interest is payable ANNUALLY, 10% PV of Future Interest Payments (EIR) xx
nominal rate per annum
Bonds xx
‒ 12% prevailing market rate of interest for
similar bonds w/o warrants
‒ PV of 1 @ 12%, 10 periods = 0.322 Example: (Given: w/o conversion privilege)
‒ PV of OA @ 12% 10 periods = 5.65 ‒ 5,000, 5yr bonds, Face Amount P1000
each at 105
PV of Principal (5Mx0.322) 1,610,000 ‒ WITH Conversion Privilege: P1000 bond
PV of Future Interest Payments for 20 equity shares, P50 par
(10% x 5M x 5.65) 2,825,000 ‒ Reliably determined that bonds sell only @
Total PV 4,435,000^ 98 w/o conversion privilege
Total Issue Price (5Mx105%) 5,250,000**
Issue Price of bonds w/ warrants 5,250,000** Issue Price w/o conversion priv.
PV of Bonds Payables (4,435,000) ^ (5,000,000x98%) (4,900,000)
Residual Amount (Warrants) 815,000* Residual Amount (Warrants) 350,000*
Journal Entry (Issuance of Bonds) Bonds Payable 5,000,000
Cash 5,250,000** Allocated Issue Price (4,900,000)
Discount on Bonds Payable 565,000 Discount on BP 100,000***
Bonds Payable 5,000,000 Journal Entry
Share Warrants Outstanding 815,000* Cash (5Mx105%) 5,250,000**
Discount on BP 100,000***
Bonds Payable 5,000,000
SP – conversion privilege 350,000*
Example: (MV of Bonds UNKNOWN) Example
(SAME GIVEN) at year end:
‒ Semi annual 8% nominal interest rate/yr ‒ BP- 12% convertible P5,000,000
‒ Prevailing market rate of interest 10% ‒ Premium on BP P200,000
‒ Semiannual: 10% = 5%, 5yrs = 10 periods ‒ Share Cap, P40par, 400,000
‒ PV of 1 5%, 10 periods = 0.6139 authorized shares, 250,000 issued,
‒ PV of OA 5%, 10 periods= 7.72 P10,000,000
‒ SP- issuance P3,000,000
PV of Principal (5Mx0.6139) 3,069,500 ‒ SP- conversion privilege P500,000
PV of Semiannual Interest 1,544,000 ‒ Conversion ratio: 20 shares for each
Payments (5Mx4%x7.72) P1,000 bond =100,000 shares
Total PV 4,613,500 (5M/1,000x20=100,000)
‒ Cost (conversion)P100,000
Issue Price of Bonds w/ CP 5,250,000** ‒ Accrued interest (paid) P150,000
PV of Bonds Payable (4,613,000)
Residual Amount (CP) 636,500* Bonds Payable (CA) 5,000,000
Premium on BP 200,000
Journal Entry SP- Conversion Privilege 500,000
Cash 5,250,000** Total Consideration 5,700,000
Discount on NP 386,500 Par value of Shares issued
Bonds Payable 5,000,000 (100,000x40) (4,000,000)
SP- Conversion Privilege 636,500* Share Premium 1,700,000
Journal Entry
Bonds Payable 5,000,000
2, CONVERSION OF BONDS Premium on BP 200,000
SP-Conversion Privilege 500,000
CA of Bonds = Share Capital Issued Interest Expense 150,000
“effective price” as a result of conversion Share Capital 4,000,000
SP- Issuance 1,700,000
PAS 32- NO GAIN/LOSS on conversion at maturity
Cash 150,000
convertible bond is an equity and the
conversion is an exchange of equity cap. to another
SP- Issuance 100,000
Cash 100,000
Any cost incurred in bond conversion -
DEDUCTED from Share Premium OR DEBIT to
Payment of Convertible Bonds at Maturity
“Share Issue Cost”
BP- Due 12/31/2020 P5,000,000
‒ Convertible & issued 1/1/2011
Accounting Procedures
Share Capital P10,000,000
1. Amortization of Discount & Issue Cost or
SP- Issuance P4,000,000
Premium up to date of Conversion
SP – Conversion Privilege P400,000
2. FA of bonds converted +unamortized
Interest rate payable every 12/31 10%
premium or discount +issue cost shall be
Original Issuance of BP P6,000,000 allocated as
cancelled
follows:
3. Accrued interest paid @ interest date
Original Issue Price 6,000,000
-IF not paid, it is added to bonds to be
Issue Price w/o Conversion Option 5,600,000
converted to get the CA (charged to
SP- Conversion Option 400,000
INTEREST EXPENSE)
Issue Price w/o Conversion Option 5,600,000
Face Amount of BP 5,000,000
Premium on BP 600,000
Journal Entry (Bonds NOT converted but fully
paid on 12/31/20)
1. Payment
Bonds Payable 6,000,000
Interest Expense 6,000,000
Cash 6,000,000
2. Close the SP from Conversion Privilege
SP- Conversion Privilege 400,000
SP- Issuance 400,000
Payment of Convertible Bonds BEFORE
Maturity
BP 8% Convertible Due 12/31/2025 P5,000,000
Premium on BP P300,000
Share capital P8,000,000
SP- Issuance P1,000,000
SP – Conversion Privilege P600,000
Interest payable annually every 12/31
Quoted price w/ conversion privilege plus interest
on 12/31/20 108
Quoted price w/o conversion privilege 103
FV of Bonds w/ CP (5Mx108) 5,400,000
FV of Bonds w/o CP (5Mx103) (5,150,000)
FV of Conversion Privilege (Equity) 250,000
Bonds Payable 5,000,000
Premium on BP 300,000
CA of Bonds Payable 5,300,000
Payment = FV of Bonds w/o CP (5,150,000)
Gain on Extinguishment 150,000
Journal Entries
1. Payment before Maturity
Bonds Payable 5,000,000
Premium on BP 300,000
SP - Conversion Privilege 250,000
Cash 5,400,000
Gain on Extinguishment 150,000
2. Close the remaining balance of SP-CP
SP-CP 350,000
SP-Issuance (600,00-250,000) 350,000
