PAS 32 COMPOUND FINANCIAL INSTRUMENTS

(Please study Chapter on Bonds Payable to fully comprehend and make the most out of this material) 

Financial Instrument gives on entity a financial asset and a financial liability or equity instrument of
another entity, thus, the term encompasses financial asset, liability and equity instrument.
Characteristics: (CTR)
 There must be a Contract.
 There are at least TWO contracting parties.
 It shall give RISE to a financial asset for a party and financial liability or equity
instrument of another party.
Financial Liability- is a contractual obligation (a) to deliver cash or other financial asset to an entity or
(b) to exchange financial instruments with another entity.
-such are payable in determinable sums of money or is valued in a specific amount of money.
Examples: Accounts Payable, Notes Payable, Loans Payable, Bonds Payable
Equity Instrument is any contract that reflects a residual interest in the assets of an entity after liabilities.
Examples: Ordinary Share Capital, Preference Share Capital, Share Warrants, Share Options
Compound Financial Instruments (CFI) have both a liability and equity component from the issuer’s
perspective. (Example: Convertible Bonds, Bonds issued with share warrants)

How to account for CFI?

Split Accounting, as mandated by PAS 32 CFI’s liability and equity component are to be
accounted for and presented separately in accordance to their nature. It shall be made at the issuance and
cannot be revised for subsequent interest rate, share price or other price changes.
Proceeds from the issuance of CFI shall be allocated between the debt component and equity
component using the residual approach. The fair value of the debt instrument is determined and any
excess in the proceeds from issuance shall be allocated to the equity component.

NOTE: The amount allocated to the debt component shall be the market value of the instrument per se.
Valuation of debt instruments shall be in accordance to the existing standards

A. Bonds Payable with Share Warrants

Share Warrants- enable bond holders to acquire equity shares at a specified price at a definite
period.
NOTE/S:
Accounting treatment would be the same regardless whether share warrants are detachable or
non-detachable.
Illustration:
Pro forma Entry:
> Cash XX
Discount on Bonds Payable XX
Bonds Payable XX
Share Warrant Outstanding XX
Premium on Bonds Payable XX
Formula:
Issue Price with Ex-Warrants XX
Less: Market Value of Bonds Ex-Warrants XX -Usually given
Share Warrant Outstanding from Issuance XX
 On January 1, 2020, ABC, Co. issued, 5,000 of its 8%, 10 year, Php 1,000.00 face value
bonds with share warrants at 110. Each bond carries a share warrant which permits the holder to
purchase 20 ordinary shares, Php 10.00 par value, at Php 12.00 per share. On the same date, the
market value of bonds ex-warrants is 98.
Requirements: A. Prepare the necessary journal entries to record the issuance of bonds.
B. Journal Entry to record the exercise 80% of Share Warrants
C. Journal Entry to record the expiration of remaining Share Warrants
D. Assuming the market value of bonds ex-warrants is unknown prepare the entry to
record the issuance of the bonds. Market Interest rate for similar bonds at the time of
issuance is 12%. The present value of 1 at 12% for 10 periods is 0.322 and present
value of ordinary annuity of 1 at 12% for 10 periods is 5.65.

A. Issue Price with Warrants (5,000 X Php 1,000.00 X 110%) Php 5,500,000.00
Less: Market Value of Bonds Ex-Warrants (5,000 X Php 1,000.00 X 98%) 4,900,000.00
Share Warrant Outstanding from Issuance 600,000.00

> Cash 5,500,000.00

Discount on Bonds Payable 100,000.00
Bonds Payable 5,000,000.00
Share Warrants Outstanding 600,000.00

B. 80% of Share Warrants are exercised

> Cash (20 Shares X 5,000 Bonds X Php 12.00 X 80%) 960,000.00
Share Warrant Outstanding 480,000.00
Ordinary Share Capital 800,000.00
Share Premium 640,000.00
C. 20% of Share Warrants expired
> Share Warrants Outstanding (Php 600,000.00 X 20%) 120,000.00
Share Premium- Unexercised Warrants 120,000.00
D. Issue Price with Warrants (5,000 X Php 1,000.00 X 110%) Php 5,500,000.00
Less: Present Value of Bonds (Note 1) 3,870,000.00
Share Warrant Outstanding from Issuance 1,630,000.00
Note 1
Present Value of Principal (Php 5,000,000.00 X 0.322) Php 1,610,000.00
Present Value of Interest [(Php 5,000,000.00 X 8%) X 5.65) 2,260,000.00
Total Present Value 3,870,000.00

> Cash 5,500,000.00

Discount on Bonds Payable 1,130,000.00
Bonds Payable 5,000,000.00
Share Warrants Outstanding 1,630,000.00
Remember: Always look for the market value of the debt instrument first, and deduct it
from the proceeds of the issuance, in cases where market value is unknown, use the
effective interest method. In recording exercise of warrants, remember to only record
the warrants which were exercised (Look at B and C from illustration above).
Accounting treatment is the same regardless whether detachable or non-detachable
warrants. 
B. Convertible Bonds
- Give the holders the right to convert their bond holdings into share capital or other
securities of the issuing entity within a specified period of time.
- ISSUANCE: Residual approach would still be used in accounting for convertible
bonds, thus, the issue price will be allocated between bonds payable and conversion
privilege. The same method used in accounting for bonds with share warrants will
still utilized- the market value of the bonds without conversion privilege will be
compared to the total issue price (proceeds from issuance), the difference will be
allocated to Share Premium- Conversion Privilege. In the absence of market value of
the bonds without conversion privilege, present value of bonds payable and future
interest payments shall be used- effective rate or market interest rate for similar
bonds.
- CONVERSION:
Journal Entries:
> Cash (Selling Price/Proceeds) XX
Discount on Bonds Payable* XX
Premium on Bonds Payable* XX
Bonds Payable (at face value)* XX
Share Premium from Bonds Conversion Privilege XX

*Bonds shall be accounted for in accordance to the standard with no changes.

Formula for Share Premium from Bonds Conversion Privilege:
Total Issue Price XX
Less: Market Value/ Issue Price of Bonds without Conversion Privilege
Bonds Payable (at face value) XX
Less: Discount on Bonds Payable XX
Add: Premium on Bonds Payable XX XX
Share Premium from Bonds Conversion Privilege XX
Illustrations:
1. Convertible Bonds- Market Values of Bonds with or without conversion privilege are
determinable.

An entity issued 5,000, 5-year bonds, face value of Php 1,000.00 at 110. The bonds contain a
conversion privilege that provides for an exchange of Php 1,000.00 bond for 20 equity
securities with par value of Php 40.00. It is reliably determined that the bonds would be sold
at 95 without conversion privilege.

Journal Entries:

Issuance:
> Cash (Selling Price/Proceeds) 5,500,000.00
Discount on Bonds Payable 250,000.00
Bonds Payable (at face value) 5,000,000.00
Share Premium from Bonds Conversion Privilege 750,000.00
Total Issue Price Php 5,500,000.00
Less: Market Value/ Issue Price of Bonds without Conversion Privilege 4,750,000.00
Share Premium from Bonds Conversion Privilege 750,000.00
 Conversion: (Pro-forma Entry)
> Share Premium from Bonds Conversion Privilege XX
Bonds Payable (at face value) XX
Interest Expense* XX
Discount on Bonds Payable XX
Ordinary Share Capital XX
Share Premium XX
*Interest Expense shall be recorded using Effective Interest Method (See other
Chapter for review.
Note: Discount on Bonds Payable or Premium on Bonds Payable are amortized using the
Effective Interest Method.

2. Market Value of the convertible bonds are unknown.

On January 1, 20X1, Brendon, Co. issued, 5,000 of its 8%, 10 year, Php 1,000.00 face
value convertible bonds with share warrants at 110. Each bond permits the holder to convert
each bond into an ordinary share.
The market value of bonds without the conversion privilege is unknown. Prepare the
entry to record the issuance of the bonds. Market Interest rate for similar bonds at the time of
issuance is 12%. The present value of 1 at 12% for 10 periods is 0.322 and present value of
ordinary annuity of 1 at 12% for 10 periods is 5.65.

Journal Entry:
Issuance:
> Cash (Selling Price/Proceeds) 5,500,000.00
Discount on Bonds Payable 1,130,000.00
Bonds Payable (at face value) 5,000,000.00
Share Premium from Bonds Conversion Privilege 1,630,000.00

Issue Price with Conversion Privilege (5,000 X Php 1,000.00 X 110%) Php 5,500,000.00
Less: Present Value of Bonds (Note 1) 3,870,000.00
Share Premium from Bonds Conversion Privilege 1,630,000.00

Present Value of Principal (Php 5,000,000.00 X 0.322) Php 1,610,000.00

Present Value of Interest [(Php 5,000,000.00 X 8%) X 5.65) 2,260,000.00
Total Present Value 3,870,000.00
3. Payment of Convertible Bonds at Maturity
On December 31, 2022, the following balances show the following balances before
payment:
Bonds Payable- due on December 31, 2022 Php 10,000,000.00
Share Capital 20,000,000.00
Share Premium – issuance 8,000,000.00
Share Premium from Bonds Conversion Privilege 800,000.00
The bonds are convertible and originally issued on January 1, 2013. The price of the
bonds on the date of issuance without the conversion privilege was Php 11,200,000.00. The bonds
were issued at Php 12,000, 000.00. The stated interest rate is 10% payable annually every
December 31. The bonds already matured, the premium on the issuance of bonds were fully
amortized on December 31, 2022. On the same date, bonds were not converted.
 Journal Entries:
Payment on December 31, 2022:
> Bonds Payable (at face value) 10,000,000.00
Interest Expense 1,000,000.00
Cash 11,000,000.00
Closing of Conversion Privilege:
> Share Premium from Bonds Conversion Privilege 800,000.00
Share Premium - Issuance 800,000.00

Points to Remember:
 In accounting for CIF’s, regardless whether Bonds with Conversion Privilege or Bonds with share
warrants, the equity and debt component shall be accounted for separately using the residual
method (See: formula below).
Proceeds from the issuance of CIF XX
Less: Market Value of the Debt Instrument XX
Conversion Privilege XX
 The debt component shall be accounted for using the effective interest method after the valuation
from the above point (See: Chapter on Bonds Payable).
 Always remember that Share Premium from Conversion Privilege is closed to Share Premium
from Issuance on maturity date.
 On payment of bonds before maturity date, the following formulas and journal entries may be
utilized.
Bonds Payable XX
Add (Deduct): Premium/ (Discount) XX
Carrying Amount of the Bonds on the date of payment (See: Chapter on Bonds) XX
Less: Fair of the Bonds without equity component (on the date of payment) (XX)
Gain (Loss) on Extinguishment XX

Bonds with Equity Component (Fair Value on Date of Payment) XX

Less: Bonds without Equity Component (Fair Value on Date of Payment) XX
Fair Value of the Equity Component XX

> Bonds Payable (at face value) XX

Discount on Bonds Payable* XX
Loss on Extinguishment* XX
Share Premium- Conversion Privilege
Premium on Bonds Payable* XX
Cash XX
Gain on Extinguishment* XX

In the middle of the difficulty lies opportunity –Albert Einstein

Do not be discouraged when you are at the rock bottom because it only means the it is going to
be an uphill from right thereon.