FAR 23_COMPOUND FINANCIAL INSTRUMENTS

FAR23 COMPOUND FINANCIAL INSTRUMENTS

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RELATED STANDARDS: PFRS 9 – FINANCIAL INSTRUMENTS; PAS 32
– FINANCIAL INSTRUMENTS: PRESENTATION
TOPIC OUTLINE

Definition & Accounting

COMPOUND
FINANCIAL
Bonds with Warrants
INSTRUMENTS
(PRFS 9) (PAS 32) Common Types of Compound
Financial Instruments
Convertible Bonds

LECTURE NOTES
DEFINITION AND ACCOUNTING
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".
Typical Financial Instrument Asset on one party Liability OR Equity on another party
Compound Financial Instrument Asset on one party Liability AND Equity on another party
ACCOUNTING FOR COMPOUND FINANCIAL INSTRUMENT
If the financial instrument contains both a liability and an equity component, PAS 32 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 an equity.
The approach in accounting for a compound financial instrument is to apply "split accounting" through
RESIDUAL APPROACH.
STEP 1: Compute or determine the fair value of the liability component. (Fair value of bonds payable
i.e. the present value of contractual cash flows)
STEP 2: 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.
COMMON FORMS OF COMPOUND FINANCIAL INSTRUMENT
BONDS PAYABLE WITH SHARE WARRANTS
When the bonds are sold with share warrants, the bondholders are given the right to acquire shares of the
issuing entity at a specified price at some future time.
Actually, when bonds are sold with share warrants two securities are sold - the bonds and the share
warrants.
Share warrants attached to a bond may be detachable or non-detachable. Detachable share warrants can
be traded separately from the bond while non-detachable share warrants cannot be traded separately.
SUMMARY OF JOURNAL ENTRIES
Upon Issuance Upon Exercise
Cash (Net Proceeds) xx Cash (@ Exercise Price) xx  
Discount on Bonds Payable xx Share Capital xx
Premium on Bonds Payable xx Share Premium xx
(OSWO) xx  
Bonds Payable (@Face Value) xx (OSWO) xx  
        Share Premium   xx
NOTE: OSWO (ordinary share warrants outstanding) is presented within share premium. Retirement of
bonds is a separate transaction and does not affect the status of share warrants. When share
warrants expire, the journal entry would be:
OSWO xx
Share premium xx
CONVERTIBLE BONDS
Convertible bonds are bonds that can be exchanged by for equity shares of the issuing entity.
Accordingly, the issuance of convertible bonds shall be accounted for as partly liability and partly equity.
The issue price of the convertible bonds shall be allocated between the bonds payable and the
conversion privilege.

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FAR 23_COMPOUND FINANCIAL INSTRUMENTS

Upon Issuance Upon Conversion

Cash (Net Proceeds) xx Bonds Payable xx  
Discount on Bonds Payable xx Discount on Bonds Payable xx
Premium on Bonds Payable xx Premium on Bonds Payable xx
Bond Conversion Privilege (BCP) xx Share Capital xx
Bonds Payable (@Face Value) xx Share Premium xx
 
Bond Conversion Privilege (BCP) xx  
        Share Premium  xx
NOTES:
(1) Upon conversion, the entity will issue shares of stock to extinguish the existing liability (bonds
payable). Thus, the liability to be extinguished shall be the updated carrying amount of the bonds
payable. This is the main difference of convertible bonds from bonds with warrants. Bonds with
warrants require cash in order for the entity to issue shares (a typical issuance of shares).
(2) Bonds payable and BCP are interrelated from one another. When bonds are converted or retired, BCP
is extinguished. BCP is presented within share premium.
(3) When bonds are retired prior to maturity, the retirement price shall be allocated between bonds and
equity component, consistent with how the original issue price was allocated (Residual Approach).
The gain or loss on retirement on bonds payable is to be presented within profit or loss while
gain on retirement of BCP is presented in share premium and loss on retirement of BCP is
charged first to related share premium and any excess is charged to retained earnings.
(4) When convertible bond is not converted but paid at maturity, the carrying amount of the bond equal
to face value is derecognized, thus, there is no gain or loss on retirement of bonds. The balance of
BCP shall be derecognized and credited to share premium.
(4) Upon expiration of the bond conversion privilege, the entry is:
BCP xx
Share premium xx

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FAR 23_COMPOUND FINANCIAL INSTRUMENTS

DISCUSSION EXERCISES
STRAIGHT PROBLEMS
BONDS WITH SHARE WARRANTS
1. On January 1, 2019, MONEY HEIST CORP. issued 3-year, 10% P2,000,000 bonds at 110. The bonds
pay interest every December 31. Each P1,000 bond has 2 detachable warrants which entitles the
holder to purchase one share of the Company for P300 per share. On that date, the quoted market
value of each warrant was P10. MONEY HEIST’s share have a par value of P200. Without the
warrants, the bond has a market value at a yield of 8%. On November 30, 2019, all of the share
warrants are exercised.
REQUIREMENTS: (1) What is the increase in shareholders' equity arising from the issuance of bonds
on January 1, 2019? (2) What is the net increase in equity as a result of the exercise of share
warrants on November 30, 2019?

CONVERTIBLE BONDS
2. KINGDOM COMPANY issued 3,000 convertible bonds on January 1, 2019. The bonds have a three-
year term and are issued at 105 with a face value of P1,000 per bond. Interest is payable annually in
arrears at a nominal 6% interest rate. Each bond is convertible at any time up to maturity into 100
ordinary shares with par value of P8. When the bonds are issued, the prevailing market interest rate
for similar debt instrument without conversion option is 9%.
REQUIREMENTS:
(a) On the date of issue, what amount of the proceeds represents the equity component?
(b) If the bonds were converted on June 30, 2021, what is the net increase in equity because of the
conversion?
(c) Assuming 2,000 bonds were converted on June 30, 2021, what is the net increase in equity
because of the conversion?
(d) Assuming on December 31, 2020, all the convertible debt instruments were retired for
P2,850,000. The prevailing rate of interest on a similar debt instrument as of December 31,
2021 is 8% without the conversion option. How much is the gain or loss that should be reported
in the profit or loss on the retirement of the convertible debt instruments?
MULTIPLE CHOICE (THEORIES)
1. When an entity issued convertible bonds, how will share premium be computed if the bonds were
converted into ordinary shares?
A. It is the difference between the face value of the bonds and the total par or stated value of the
shares issued.
B. It is the difference between the carrying amount of the bonds and the total par or stated value
of the shares issued.
C. It is the difference between the carrying amount of the bonds plus share premium from
conversion privilege and the total par or stated value of the shares issued.
D. It is the difference between the face value of the bonds plus the share premium from conversion
privilege and the total par or stated value of the shares issued.
2. Which of the following is an equity item?
Ordinary share Bond conversion
warrants outstanding Privilege
A. Yes No
B. No Yes
C. Yes Yes
D. No No
3. Which of the following is a compound financial instrument?
Convertible bonds Convertible preference shares Bonds with warrants
A. Yes Yes No
B. Yes No Yes
C. Yes Yes Yes
D. No Yes Yes
E. No No Yes
4. An entity issued bonds with warrants with net proceeds which is higher than the face value. The fair
market value of the bonds without warrants is lower than the face value. Based on the given
information, which of the following is incorrect regarding the journal entry upon issuance of bonds?
A. Ordinary share warrants outstanding is credited
B. Premium on bonds payable is credited
C. Discount on bonds payable is debited
D. Cash is debited equal to the net proceeds from issuance

5. In relation to early retirement of convertible bonds, which of the following statements is incorrect?
S1: Residual approach will also be applied in allocating the retirement price between the liability and
equity component of the compound financial instrument. TRUE

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S2: The gain or loss on retirement on bond conversion privilege is to be presented within profit or
loss. FALSE, sa equity siya not sa P/L.
A. S1 only C. Both statements
B. S2 only D. None from the statements

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