CHAPTER 7 COMPOUND FINANCIAL INSTRUMENT TECHNICAL KNOWLEDGE To define a financial instrument. To describe a financial liability and an equity instrument. To define a compound financial instrument. To identify common forms of compound financial instrument. To know the accounting for a compound financial instrument. 225FINANCIAL INSTRUMENT / 1 PAS 32, Paragraph 11, defines a financial instrument as any . set of one entit: contract that gives rise to both a financial ass? pee entity and a financial liability or equity instrum isti ial i ment Characteristics of a financial instru’ a. There must be a contract. . tract. b. There are at least two parties to the contract, one ‘The contract shall give rise to a financial asset of one party and financial liability or equity another party. Financial liability A financial liability is a contractual obligation: 4 ther entiy, a. To deliver cash or other financial asset PP ether entity b. To exchange financial instruments wit favorable. under conditions that are potentially wn Financial liabilities a. Trade. accounts payable b. Notes payable c. Loans payable d. Bonds payable Nonfinancial liabilities a. Deferred revenue and warranty OO eee ooo financial liabilities because the outflow 0: eons benefit is the delivery of goods anil services rather than a contractual obligation to pay cash. : b. Income tax payable is not a financial liability ae it is statutory or imposed by law and noncontractual c. Constructive obligations are not financial lial 7 because the obligations do not arise from contracts. Equity instrument An equity instrument is any contract that evidences a oe interest in the assets of an entity after deducting ai liabilities. Equity instruments include ordinary share capital, preference share capital and warrants or option. 226COMPOUND FINANCIAL INSTRUMENT 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. In other words, one component of the financial instrument meets the definition of a financial liability and another component of the financial instrument meets the definition of an equity instrument. The common examples of compound financial instrument are: a. Bonds payable issued with share warrants b. Convertible bonds payable Accounting for compound instrument The issuer of a financial instrument shall evaluate the terms of the instrument whether it contains both a liability and an equity component. If the financial instrument contains both a liability and an equity component, PAS 32 mandates that such components shall be accounted for separately. The approach in accounting for a compound financial instrument is split accounting. Split accounting means that the consideration received from the issuance of the compound financial instrument shall be allocated between the liability and equity components The fair value of the liability component is first determined. The fair value of the liability component is then deducted from the total consideration received from the issuance of the compound financial instrument. The residual amount is allocated to the equity component. 227Bonds payable issued 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, in this case, two securities are sold — the bonds and the share warrants. Share warrants attached to bonds payable may be detachable or nondetachable. Detachable warrants can be traded separately from the bond and nondetachable warrants cannot be traded separately. IFRS does not differentiate whether the equity component is detachable or nondetachable. Whether detachable or nondetachable, the share warrants have a value and shall be accounted for separately. Share warrants are rights granted to the holder to acquire shares of the issuer at a specified price during a specified period. Allocation of issue price The bonds are assigned an amount equal to the market value of the bonds ex-warrants, regardless of the market value of the share warrants. The residual amount or remainder of the issue price shall then be allocated to the share warrants. The residual approach is based on the definition of an equity instrument as a contract that evidences a residual interest in the assets of an entity after deducting all of the liabilities. Illustration An entity issued 5,000 10-year bonds payable, face amount P1,000 per bond, at 105. Each bond is accompanied by one warrant that permits the bondholder to purchase 20 equity shares, par P50, at P55 per share, or a total of 100,000 shares, 5,000 x 20. The market value of the bond without warrant at the time of issuance is 98Journal entries 1 To record the issuance of the bonds payable: Cash (5,000,000 x 105) 5,250,000 Discount on bonds payable 100,000 Bonds payable 5,000,000 Share warrants outstanding 350,000 Issue price of bonds with warrants 5,250,000 Market value of bonds without warrants (6,000,000 x 98) (4,900,000) Residual amount allocated to share warrants 350,000 Face amount of bonds payable 5,000,000 Market value of bonds without warrants 4,900,000 Discount on bonds payable 100,000 2. To record the exercise of 60% of the warrants: Cash (60,000 shares x 55) 3,300,000 Share warrants outstanding 210,000 Share capital 3,000,000 Share premium 510,000 Shares issued (60% x 100,000) 60,000 Issue price of shares (60,000 x 55) 3,300,000 Share warrants exercised (60% x 350,000) 210,000 Total consideration 3,510,000 Par value of shares issued (60,000 x 50) 3,000,000 Share premium 510,000 3. To record the expiration of the remaining warrants: Share warrants outstanding 140,000 i Share premium —unexercised warrants 140,000 Share warrants outstanding 350,000 Share warrants exercised 210,000 Share warrants unexercised 140,000 The expiration of remaining warrants is credited to share premium from unexercised share warrants. 229~~ Vr Market value of bonds without warrants unknown ithout the In the absence of market value of bonds witho warrants, the amount allocated to the bonds payable 7 eae to the present value of the principal bond liability plus the present value of the future interest payments Using the effective or market interest rate for similar bonds payable without the share warrants. Illustration oo . ds payable An entity issued P5,000,000 face amount 5-year bon at 120. Each P1,000 bord was issued with 20 nondetachable share warrants. Each warrant entitled the bon 4 ” tn a purchase one share of P20 par value for P25. The interest ra is 10% payable annually every December 31. - : i bonds The prevailing market rate of interest for similar bor without warrants is 12%. The PV of 1 at 12% De tee is 0.57 and the PV of an ordinary annuity of 1 at 12% periods is 3.60. Present value of principal (5,000,000 x 0.57) 2,850,000 Present value of interest payments 1,800,000 (10% x 5,000,000 = 500,000 x 3.60) 1,800,000 Total present value of bonds payable 4,650,000 Issue price of bonds with warrants (5,000,000 x 120) Eppa eco) Present value of bonds payable —— Residual amount allocated to share warrants ed To record the issuance of the bonds payable: Cash 6,000,000 Discount on bonds payable 360, Bonds payable Soares Share warrants outstanding _ To record the exercise of the share warrants: Cash (100,000 x 20) 2,000,000 Share warrants outstandin, 1,350,000 2,500,000 Share capital (100,000 x 25) "850,000 Share premium , Number of share warrants (5,000 x 20) 100,000 Number of shares (one warrant one share) 100,000 230Convertible bonds payable An entity frequently makes its bond issue more attractive to investors by making the bonds convertible. Convertible bonds are bonds which give the holders the right to convert their bondholdings into share capital or other securities of the issuing entity within a specified period of time. Often, the conversion Privilege becomes less attractive as time goes by. : For example, a 15-year, P1,000 bond may be convertible into 20 equity shares during the first five years from date of issue, 10 equity shares the next five years and may not be convertible during the last five years. When convertible bonds are issued at a premium or discount, amortization period is up to the maturity date instead of the conversion date because it is impossible to predict, if at all, that the conversion privilege will be exercised. Accounting problems arise in two situations, namely: a. When the convertible bonds are originally issued b. When the convertible bonds are converted Original issuance Convertible bonds are conceived as compound financial instruments. Accordingly, the issuance of convertible bonds payable shall be accounted for as partly liability and partly equity. Otherwise stated, the issue price of the convertible bonds shall be allocated between the bonds payable and the conversion privilege. 231Allocation of issue price The economic effect of issui rtible bonds payable ig . issuing conve! substantially the same ae issuing simultaneously bonds payable with share warrants. ‘The bonds are assigned an amount equal to the market value of the bonds without the conversion privilege. The residual amount or remainder of the issue price shall then be allocated to the conversion privilege or equity component. In the absence of market value of the bonds payable without conversion privilege, the amount allocated to the bonds payable is equal to the present value of the principal bond liability plus the present value of future interest payments using the effective or market interest rate for similar bonds payable without conversion privilege. Hlustration An entity issued 5,000, 5-year bonds payable, face amount P1,000 each at 110. The bonds contain a conversion privilege that provides for an exchange of a P1,000 bond for 20 equity shares with par value of P50. It is reliably determined that the bonds would sell only at 95 without the conversion privilege. Cash 5,500,000 Discount on bonds payable 250,000 Bonds payable 5,000,000 Share premium — conversion privilege 750,000 “otal issue price of bonds payable (5,000,000 x 110) 5,500,000 Issue price of bonds without conversion privilege (5,000,000 x 95%) (4,750,000) Residual amount allocated to conversion privilege 750,000 Bonds payable 5,000,000 Allocated issue price 4,750,000 Discount on bonds payable 250,000Market value of convertible bonds unknown An entity issued 5,000 6-year bonds paynble, face amount P1,000 each bond at 120. Tho bonds contain a conversion privilogo that provides for an exchange of P1,000 bond for 20 equity sharos with par valuo of P25. ; The convertible bonds without conversion privilege have no known market value at the date of issuance. The stated interest is payable semiannually at a nominal rate of 8% per annum, When tho bonds are issued, the prevailing market rate of interest for similar bonds payable without conversion privilege is 10% per annum, The present value of 1 at 5% for 10 periods is 0.61 and the present of an ordinary annuity of 1 at 6% for 10 periods is 7.72. The semiannual effective or market interest rate is 5% which is one-half of 10%. ‘The interest is payable semiannually. Since the life of the bonds is 5 years, then there are 10 interest periods. Present value of principal (6,000,000 x 0.61) . 8,050,000 Present value of semiannual interest payments (5,000,000 x 4% = 200,000 x 7.72) 1,544,000 Total present value of bonds payable 4,594,000 Issue price of bonds with conversion privilege 6,000,000 Present value of bonds payable (4,594,000) Residual amount allocated to conversion privilege 1,406,000 Journal entry Cash (5,000,000 x 120) 6,000,000 Discount on bonds payable 406,000 Bonds payable 5,000,000 Share premium ~ conversion privilege 1,406,000 Bonds payable 5,000,000 Present value of bonds payable 4,594,000 Discount on bonds payable 406,000 233Conversion of bonds payable Ifbonds are converted into share capital of the Pagette te the accounting problem is the determination of a val e assigned to the share capital issued. The carrying amount of the bonds is the measure of by arats capital issued because the carrying amount is the "effective price” for the shares issued as a result of the con 2 Application Guidance 32 of PAS 32 provides that there is no gain or loss on conversion at maturity. The reason is that the convertible bond ie ae a substance as an equity and the conversion is really an exchange of one type of equity capital for another. Any ost, incurred in connection with the, bond conversion shall be deducted from share premium arising from conversion. The carrying amount of the bonds payable is equal to the face amount plus accrued interest if not paid, plus unamortized premium on bonds payable or minus unamortized discount on bonds payable and bond issue cost, Accounting procedures a. The amortization of discount and issue cost 4 premium up to the date of conversion shall be recorded. b. The face amount of the bonds payable converted shall be canceled together with the related unamortized premium or discount on bonds payable and bond issue cost. If only a portion of the bonds is oo: ee unamortized premium or discount on bonds payal ee issue cost balance shall be canceled proportionately. c. Normally, conversion is at an interest date. When at other dates, the accrued interest up to the date of conversion is ordinarily paid. If the interest is not paid, it is added to the face amount of the bonds payable converted to get the carrying amount of the bonds payable for conversion purposes. The accrued interest is charged to interest expense 234Illustration eos i iti wed the followin, balances at year-end position sho g Bonds payable — 12% convertible 5,000,000 Premium on bonds Payable 200,000 Share capital, P40 par, 40,0 authorized and 250,000 shorn ieeved 10,000,000 Share premium ~ issuance = Share premium — conversion privilege 500,000 On the same date, the bonds are converted into share capital. The coversion ratio is 20 shares for each P1,000 bond or a total of 100,000 shares, Cost incurred in connection with the conversion amounted to P100,000. The accrued interest on the bonds payable on the date of conversion is P150,000 which is paid in cash. Bonds payable 5,000,000 Premium on bonds payable 200,000 Share premium — conversion privilege 500,000 Total consideration 5,700,000 Par value of shares issued (100,000 shares x 40) 4,000,000 Share premium ~ issuance 1,700,000 Journal entry for the conversion Bonds payable 5,000,000 Premium on bonds payable 200,000 Share premium — conversion privilege 500,000 Interest expense 150,000 Share capital 4,000,000 Share premium — issuance 1,700,000 Cash 150,000 Share premium ~ issuance 100,000 Cash 100,000 Note that the 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 the conversion. 235Payment of convertible bonds at maturity i ositic On December 31, 2022, the statement of cee Position showed the following balances before payment: 5,000,000 Bonds payable ~ due December 31, 2022 10,000,000 Share capital 4,600,000 Share premium ~ issuance 400,000 Share premium ~ conversion option The bonds are convertible and originally Se 1, 2013. The stated rate interest is 10% paya rice’ of the every December 31, The original issue P convertible bonds payable was P6,000,000. 6,000,000 Original issue price of bonds payable (6,600,000) Issue price of bonds without conversion option agp tapes 000 Share premium ~conversion option => : 5,600,000 Issue price of bonds without conversion option 5,000,000 Face amount $00,000 Premium on bonds payable = ium on’ bonds Since the bonds already matured, the premium on bon payable of P600,000 is already fully amortized on December 1, 2022, id The convertible bonds are not converted but fully paid on December 31, 2022. Journal entries 1. To record the payment on December 31, 2022: Bonds payable 5,000,000 tea (10% x 5,000,000) cee 5,500,000 as] The payment at maturity is equal to the face amount plus interest. option: 2. To close the share premium from conversion op Share premium ~ conversion option 400,000 aan Share premium — issuance 236Payment of convertible bonds before maturity On December 31, 2022, the entity showed the following balances: . Bonds payable ~ 8% convertible, due December 31,2027 5,000,000 Premium on bonds payable 300,000 Share capital 8,000,000 Share premium ~ issuance 1,000,000 Share premium ~ conversion privilege 600,000 The interest is payable annually every December 31. The convertible bonds are not converted but fully paid on December 31, 2022 for P5,400,000 plus accrued interest. On December 31, 2022, the quoted price of the bonds payable without the conversion privilege is 103. Payment of bonds payable on December 31, 2022 5,400,000 Fair value of bonds without conversion privilege (5,000,000 x 103) 5,150,000 Equity component 250,000 Bonds payable 5,000,000 Premium on bonds payable 300,000 Carrying amount of bonds payable 5,300,000 Payment applicable to bonds payable equal to the fair value of bonds without conversion privilege _ (6,150,000) Gain on extinguishment 150,000 The total payment of P5,400,000 to the bondholders is partly liability of P5,150,000 and partly equity of P250,000.-’ PR ® Journal entries 1. To record the payment before maturity: Bonds payable : oe Premium on bondspayable 250.000 — prenium ~ conversion privilege , 5,400,000 asl 150,000 Gain on extinguishment Interest expense (8% x 5,000,000) 400,000 400,000 Cash Ane remium from 2. Toclose the remaining balance of the share p) conversion privilege: Share premium ~ conversion privilege 350,000 Share premium — issuance (600,000 - 250,000) . 350,000 238QUESTIONS 1. Define a financial instrument. 2. What are the characteristics of a financial instrument? 3. Define a financial liability. 4. Define an equity instrument. o . Define a compound financial instrument. 2 . Explain the accounting for a compound financial instrument. ~ . What are the common examples of compound financial instrument? ~ . Explain share warrants. 9. Distinguish between detachable and nondetachable share warrants, 10. Explain the accounting for bonds payable issued with share warrants. 11. Define convertible bonds payable. 12. Explain the accounting for convertible bonds payable at the time of original issuance. 13. Explain the accounting for convertible bonds payable at the time of actual conversion into share capital. 14. Explain the accounting for full payment of convertible bonds payable at maturity. a 5. Explain the accounting for full payment of convertible bonds payable before maturity. 239PROBLEMS Problem 7-1 (IAA) At the beginning of current year, Monic Company Seiten issue 5,000 10-year bonds payable of 8% P1,000 face amount with share warrants to acquire equity shares at P30 per Share a interest on the bonds is payable annually every December 31. Each bond contains one share warrant which can be used to acquire 4 shares of P25 par value share capital. It is reliably determined that without share warrants, the bonds payable would sell at 115 with a 6% effective yield. The bond price with share warrants is 120. Al] warrants are exercised at year-end. \ Required: Prepare journal entries for the current year in connection with the bond issuance and the exercise of the share warrants. Use effective interest method of amortization, Problem 7-2 (IAA) At the beginning of current yéar, Kat Company decided to raise additional capital by issuing P5,000,000 face amount 5-year bonds payable with interest rate of 12% payable annually on December 31. To help the sale of the bonds payable, share warrants are issued — one warrant for each P1,000 bond sold. The share warrant entitled the holder to purchase five shares at P100 per share. The par value of the share is P50. It is reliably determined that the fair value of the share warrants is P30 each at the time of the issuance of the bonds payable. The bonds are sold for P5,100,000 with share warrants but would have sold only at P4,660,000 without the share warrants with 14% effective yield. Required: Prepare journal entries for the current year in connection with the bonds including the exercise of the share warrants. The effective interest method of amortization is used. 240Problem 7-3 (FRs) At the beginning of ¢ Cc A urrent year, Zamboanga Company issued P8,000,000 of 12% bonds payable maturing in 5 years. b a 2 Fo eee Pay interest semiannually on June 30 and The bonds included sha . bondhold ti ‘ing the bondholder nn to purchase 16.000 P100 parevalue shares for P150 per share within the next three years. The bonds and share warrant: issued at 120. The fair value ofthe share warrants at the time of issuance was P1,500,000. All share warrants were exercised at current year-end. The market rate of interest for similar bonds without the share warrants is 10%. The PV of 1 at 5% for ten periods is .61, and the PV of an ordinary annuity of 1 at 5% for ten periods is 7.72. : Required: Prepare journal entries for the currrent year in connection with the bonds. The interest method of amortization is used. Problem 7-4 (IFRS) At the beginning of current year, Silay Company issued 2,000 convertible bonds payable. The bonds have a three-year term and are issued at 110 with a face amount of P1,000 per bond, giving total proceeds of P2,200,000. Interest is payable annually in arrears at a nominal annual interest rate of 6%. Each bond is convertible at any time up to maturity into 25 shares of capital with par value of P20. The bonds are converted at the end of current year. When the bonds are issued, the prevailing market rate for similar bonds without conversion privilege is 9%. The present value of 1 at 9% for three periods is 0.77 and the present value of an ordinary annuity of 1 at 9% for three periods is 2.53. Required: Prepare journal entry to record issuance of the bonds payable, interest payment, effective amortization and bond conversion 241Problem 7-5 (IAA) Sunshine Company issued 4-year 12% convertible bonds payable with face amount of P5,000,000 at 105 on January 1, 2022 maturing on January 1, 2027 and paying interest annually on December 31. It is reliably ascertained that the bonds would sell at P4,700,000 without the conversion feature with an effective yield of 14%. Each P1,000 bond is convertible into 8 equity shares of P100 par value. On December 31, 2022, all of the bonds are converted into share capital. At this time, the share has a market value of P150 and the bonds are quoted at 101. Required: 1, Prepare journal entry to record the issuance of the bonds payable on January 1, 2022. 2. Prepare journal entry to record the interest payment and amortization for 2022. 3. Prepare journal entry to record the conversion of bonds payable on December 31, 2022 Problem 7-6 (IAA) Karen Company showed the following accounts on December 31, 2022. Bonds payable ; 5,000,000 Premium on bonds payable 250,000 Share capital - 250,000 shares authorized and 200,000 shares issued, P50 par 10,000,000 Share premium ~ issuance 2,000,000 Share premium — conversion privilege 500,000 Retained earnings 2,500,000 The bonds are convertible into 10 equity shares for every P1,000 bond. On December 31, 2022, the entire bond issue was converted and on this date, the market value of the share is 120 and the market value of the bonds is 103. The entity paid P200,000 as a result of the bond conversion. Required: Prepare journal entries for the conversion of the bonds payable on December 31, 2022. 242Problem 7-7 (AA) On January 1, 2022, Andrea Company issued 4,000 convertible bonds payable with P1,000 face amount per bond. The bonds have a three-year life and are issued at 105 or a total proceeds of P4,200,000. Interest is payable annually at 6% every December 31. Each bond is convertible into 20 ordinary shares with P50 par value. When the bonds are issued, the market rate of interest for similar bonds without conversion option is 8%. The PV of 1 at 8% for three periods is .79, and the PV of an ordinary annuity of 1 at 8% for three periods is 2.58. Required: 1. Prepare journal entry to record the original issuance of the convertible bonds payable. 2. Prepare journal entry to record the full payment of the convertible bonds at maturity on January 1, 2025. Problem 7-8 (IAA) On January 1, 2022, Arlene Company issued convertible bonds payable with face amount of P5,000,000 for 6,000,000. The bonds are convertible into 50,000 equity shares with P100 par value. The bonds have a 5-year life with 10% stated interest rate payable annually every December 31. On January 1, 2022, the fair value of the convertible bonds without conversion option is computed at P5,399,300. On December 31, 2024, the convertible bonds were not converted but fully paid for P5,550,000 excluding accrued interest. On such date, the fair value of the bonds without conversion privilege is P5,400,000 and the carrying amount of the bonds payable is P5,178,300. Required: 1. Prepare journal entry to record the original issuance of the convertible bonds payable on January 1, 2022. 2. Prepare journal entries on December 31, 2024. 243Problem 7-9 (AICPA Adapted) issued 12% At the beginning of current year, Fence Company issue P5,000,000 nonconvertible bonds payable at 103 which are due in 5 years, In addition, each P1,000 bond was issued 30 share fe for PS} each of which entitled the bondholder to os ateret is one share of Fence Company, par value P25. In . payable annually every end of the year. Qn the date of issuance, the market value of me ay was P40 and the market value of the share warrant . The market rate of interest for similar bonds Coase id dios the Present value of 1 at 14% for 5 periods is 0.5 for 5 the present value of an ordinary annuity of 1 at — periods is 3.43, i discount or 1. What amount:should be recognized as 7 premium on the original issuance of the bonds payable? a. 342,000 premium b. 342,000 discount c. 450,000 premium d. 450,000 discount 2: What amount should be recorded as equity component arising from the issuance of bonds payable? a. 150,000 b. 450,000 c. 492,000 d 0 3. What amount should be credited to sharé premium if all of the share warrants are exercised? a. 4,242,000 b. 3,500,000 ec. 3,600,000 d. 3,950,000 244Problem 7-10 (AICPA Adapted) : -year bonds Moses Company issued P5,000,000 face amount, 5-year payable at 109. Each P1,000 bond was issued with vurchese warrants, each of which entitled the bondholde= to purchase one share of P100 par value at P120. Immediately after issuance, the market value of each share warrant was P5, The stated interest rate on the bonds is 11% payable annually every end of the year, However, the prevailing market rate of interest for similar bonds without warrants is 12%. jods is 0.57 and the The present value of 1 at 12% for 5 periods is 0. : present value of an ordinary annuity of 1 at 12% for 5 periods is 3.60." 1. What is the carrying amount of the bonds payable on the date of issuance? a. 5,450,000 b. 4,830,000 c. 5,000,000 ’ d. 4,380,000 2. What amount should be recorded initially as discount or premium on bonds payable? a. 170,000 discount b. 450,000 premium ¢. 450,000 discount d. 800,000 discount 3. What amount should be recorded as equity component arising from the issuance of bonds payable? a. 450,000 b. 500,000 c. 620,000 d. 0 4. What amount should be credited to share premium if all of the share warrants are exercised? a. 1,000,000 b. 1,450,000 c. 1,500,000 d. 1,620,000 245Problem 7-11 (AICPA Adapted) At the beginning of current vear, Case Company issued 5,000,000 of 12% nonconvertible bonds payable at 103 whit are due in five years, In addition, each P1,000 bond was issued with 30 detachable share warrants, each of which entitled the bondholder to purchase, for P50, one ordinary share-of Case Company, par value P25. On the date of issuance, the quoted market value of each oa warrant was P4. The market value of the bonds ex-warran' at the time of issuance is 95. 1. What is the carrying amount of the bonds payable on the date of issuance? a. 5,000,000 b. 4,750,000 c. 5,250,000 d. 4,950,000 2. What amount of the proceeds from the bond issue oe be recognized as an increase in shareholders’ equity? a. 600,000 b. 300,000 c. 200,000 d. 400,000 38. What amount should be credited to share premium if all of the share warrants are exercised? a. 3,750,000 b. 4,350,000 c. 4,150,000 d. 4,250,000 246Problem 7-12 (AA). Moriones Company issued P5,000,000 face amount 12% 5-year convertible bonds payable at 110 at the beginning of Gaede year, paying interest semiannually on January 1 and uly 1. It is estimated that the bonds would sell only at 103 without the conversion feature. Each P1,000 bond is convertible into 10 ordinary shares with P100 par value. What amount should be reported as increase in shareholders' equity arising from the original issuance of the convertible bonds payable? a. 350,000 b. 500,000 ec. 150,000 0 Problem 7-13 (IFRS) At the beginning of current year, Susan Company issued 5,000 convertible bonds payable. The bonds-have a three-year term and are issued at 110 with a face amount of P1,000 per bond. ~ Interest is payable annually in arrears at a nominal 6% interest rate. Each bond is convertible at anytime up to maturity into 100 ordinary shares with par value of P5. When the bonds are issued, the prevailing market interest rate for similar debt instrument without conversion option is 9%, The present value of 1 at 9% for 3 periods is .77 and the present value of an ordinary annuity of 1 at 9% for 3 periods is 2.53. What amount should be recorded as equity component arising from the original issuance of the convertible bonds payable? a. 1,150,000 b. 1,650,000 c. 891,000 d. 391,000 247Problem 7-14 (AICPA Adapted) On December 31, 2022, Cey Company had outstanding 12%, P5,000,000 face amount convertible bonds payable maturing on December 31, 2027. Interest is payable on June 30 and December 31. Each P1,000 bond is convertible into 50 shares of Cey Company with P10 par value. On December 31, 2022, the unamortized premium on bonds payable was P300,000.'No equity component was recognized from the original issuance of the convertible bonds. On December 31, 2022, 2,000 bonds were converted when the share had a market price of P24. The entity incurred P20,000 in connection with the bond conversion. What amount should be recorded as share premium arising from the bond conversion? a. 1,400,000 b. 1,100,000 c. 1,380,000 d. 1,120,000 Problem 7-15 (AICPA Adapted) Spare Company had an outstanding share capital with par value of P50,000,000 and 12% convertible bonds payable with face amount of P10,000,000. Interest payment dates of the bond issue are June 30 and December 31. The conversion clause in the bond indenture entitled the bondholders to receive 40 shares of Spare Company with P20 par value in exchange for each P1,000 bond. The holders of bonds with face amount of P5,000,000 exercised the conversion privilege at year-end. The market price of the bonds at year-end was P1,100 per bond and the market price of the share was P30. The unamortized discount on bonds payable was P500,000 and the share premium from conversion privilege had a balance of P2,000,000 at the date of conversion. What amount of share premium should be recognized by reason of the conversion of bonds payable into share capital? a. 2,000,000 b. 2.750,000 c. 3,000,000 d. 1,750,000 248Problem 7-16 (AICPA Adapted) Clay Company had P¢ tible 8% bonds payable outstanding on June 30. bach PL000 bond was convertible into 10 ordinary shares of P50 par value. On July 1, the interest was paid to bondholders and the bonds were converted into ordinary shares which had a fair value of P75 per share. The unamortized premium on bonds payable was P12,000 at the date of conversion. No equity component was recognized when the bonds were originally issued. What amount should be recorded as increase in share premium as a result of the bond conversion? a, 312,000 b. 306,000 ec. 162,000 d. 300,000 Problem 7-17 (IAA) Isabel Company had outstanding share capital with par value of P50,000,000 and 12% convertible bonds payable with face amount of P10,000,000. Interest on the bond is payable annually on December 31. The conversion clause entitled the bondholders to receive 50 shares of P20 par value in exchange for each P1,000 bond. At year-end, the holders of bonds with face amount of P2,000,000 exercised the conversion privilege. The market price of the bonds on that date was P1,200 per bond and the market price of the share was P25. The premium on bonds payable at the date of conversion was P3,000,000. The share premium from conversion privilege had a balance P1,500,000 at the date of conversion. What amount of share premium should be recognized by. reason of the bond conversion? a. 450,000 b. 300,000 c. 600,000 d. 900,000 249Problem 7-18 (IAA) On December 31, 2022, Tamaraw Company showed the following balances: Bonds payable ~ 6% aoa Discount on bonds payable Beeeay Share premium — issuance eaten Share premium — conversion privilege ates i i . The The interest is payable annually every December 31 convertible bonds are not converted but fully paid on December 81, 2022 for P4,200,000 plus accrued interést. On December 31, 2022, the quoted price of the bonds payable without the conversion privilege is 95. 1. What is the carrying amount of the bonds payable on December 31, 2022? a. 4,000,000 b. 4,500,000 c. 3,500,000 d. 4,200,000 2. What amount should be recorded as gain or loss from extinguishment of bonds payable? a. 700,000 gain b. 700,000 loss c. 300,000 gain d. 300,000 loss 3. What amount should be recorded as total payment to the bondholders on December 31, 2022? a. 4,200,000 b. 4,440,000 c. 4,240,000 d. 4,040,000 250Problem 7-19 Multiple choice (IFRS) 1 p ad What is the principal accounting for a compound financial instrument? a. The issuer shall classify a compound instrument as either liability or equity. : b. The issuer shall classify the liability and equity components of a compound instrument separately as liability or equity instrument. c. The issuer shall classify, a compound instrument as a liability in its entirety, until converted into equity. d. The issuer shall classify a compound instrument as a liability in its entirety. . How are the proceeds from issuing a compound instrument allocated between the liability and equity? a. The liability component is measured at fair value and the remainder of the proceeds is allocated to the equity component. b. The proceeds are allocated to the liability and equity based on fair value. c. The proceeds are allocated to the liability and equity based on carrying amount. d. The proceeds are not allocated because the compound instrument is accounted for either as liability or equity. The proceeds from an issue of bonds payable with share warrants should not be allocated between the liability and equity components when a. The fair value of the share warrants is not readily available. b. The exercise of the share warrants within the next reporting period seems remote. The share warrants issued are nondetachable. d. The proceeds should be allocated between liability and equity under all of these circumstances. ° 2514. on ii d with When the cash proceeds from bonds psyable issue: : share warrants exceed the fair value of the bonds payable ‘without the warrants, the excess should be credited to Share premium — ordinary Retained earnings , Liability account Share premium — share warrants Bere . When bonds are issued with share warrants, the equity component is equal to a. Zero b. The excess of the proceeds over the face amount of the bonds payable. c. The market value of the share warrants. d. The excess of the proceeds over the fair value of the bonds payable without the share warrants. 252Problem 7-20 Multiple choice (AA) ab np 2 5. A bond convertible by the holder into a fixed number of ordinary shares of the issuer is a A compound financial instrument bo A primary financial instrument c. A derivative financial instrument d. An equity instrument Convertible bonds a. Have priority over other indebtedness. b. Are usually secured by a mortgage. : c. Pay interest only in the event net income 15 to cover the interest. d. May be exchanged for equity shares. sufficient A : fais 7 ? . What is the main reason for issuing convertible bond? a. The ease with which convertible bond is sold even if the entity has a poor credit rating. b. The fact that share capital has issue cost and convertible bond has none. c. Entities can obtain financing at lower rate. d. Convertible bond always sells at a premium. . The major difference between convertible bonds payable and bonds payable issued with share warrants is that upon exercise of the share warrants a. The shares are held by the issuer for a certain period before issuance to the warrant holder. b. The holder has to pay a certain amount to obtain the shares. c. The shares involved are restricted. d. No share premium can be part of the transaction Convertible bonds a. Are separated into the liability component and the expense component. . Allow an entity to issue debt financing at lower rate. c. Are separated into liability and equity components based on fair value. d. All of the choices are correct. 2536. What is the accounting for issued convertible bond? a 10. a. The instrument should be recorded solely as bond. b. The instrument should be recorded as either bond or equity but not both. | ¢. The instrument should be recorded solely as equity. d. The instrument should be recorded as part bond and- Part equity. Issued convertible bonds are a. Separated into liability and equity components with the liability component recorded at fair value and the residual assigned to the equity component b. Always recorded using the fair value option c. Recorded at face amount for the liability d. Recorded at the par value of shares . The carrying amount of bonds converted was greater than the par value of the ordinary shares issued. Which correctly states an effect of the conversion? Shareholders’ equity increased Share premium decreased Retained earnings increased A loss is recognized aoe . The conversion of bonds payable into ordinary shares is commonly recorded by a. Incremental method b. Proportional method c. Fair value method d. Book value or carrying amount method When convertible bond is not converted but paid at maturity a. A gain or loss is recorded for the difference between the carrying amount of the bond and the present value b. The amount allocated to equity is recorded as a gain. c. The amount allocated to equity is recorded as a loss. d. The carrying amount of the bond equal to face amount is derecognized.