COMPOUND FINANCIAL INSTRUMENT (CFI) Bonds)

● Bonds with equity characteristics

● A financial instrument that contains both a
LIABILITY component and an EQUITY
component.
○ When we say COMPOUND, the
components are LIABILITY and
EQUITY
Examples of Bonds with CFI:
- In order to determine, the keywords are
CONVERTIBLE and WARRANTS
Bonds with WARRANTS
● Bondholders are given the right to ACQUIRE a
specified number of ordinary shares of the
issuing corporation at a GIVEN PRICE within a
certain time period.
○ REMEMBER: We are focusing on the
part of the ISSUER, so when we say
the bondholders are given the right to
ACQUIRE, the bondholders will
purchase or acquire a specified
number of ordinary shares.
○ As a result on our part, we will issue a
specified number of ordinary shares.
○ GIVEN PRICE - pertains to the agreed
price or usually the term is option
price or exercise price.
○ Even if there is a given market value on
the date of issuance as well as on the
date of exercise, that is TOTALLY
IRRELEVANT because the cash that
we will receive will be based on the
agreed price/exercise price/option
price.
● EQUITY COMPONENT = SHARE
WARRANTS OUTSTANDING (SWO) /
Ordinary Share Warrants Outstanding (OSWO)
○ This is an equity account and
specifically, this is a share premium
account.
Quoted Price
(Face value x Quoted
price)
Examples: 101, 105, 95, Commented [1]: if more than 100% = automatically,
98 the result is PREMIUM
Effective Rate Commented [2]: if less than 100% = automatically, the
result is DISCOUNT
Bifurcation - the process of separating the CFI into
liability and equity
● The question here is how much should be
allocated to liability?
● Usually naeencounter natin yung keyword na
“without” and that’s our basis of the amount that
should be allocated to liability.
● The amount that should be allocated to liability
may be in a form of Total Amount.
○ Masaya ka dyan kasi wala namang
kailangan i-compute because the total
amount is already given in the problem.
● Remember, if the given information is Quoted
Price, you should just multiply that to the face
value.
● Usually kapag Effective Rate na yung given sa
problem, yan na yung chance na magkakamali
na tayo kasi nga sa lahat, yan ang
pinakamatrabaho.
○ You will just use the formula in
computing the issue price of the bonds.
Effective Rate Formula
PV of FACE VALUE (PV of Maturity XX
Value)
PV of PERIODIC INTEREST XX
XX
● After getting the amount allocated to liability,
that will be deducted from the total issue price
and the residual amount represents now the
EQUITY COMPONENT.

CONVERTIBLE Bonds ISSUANCE OF BONDS

● Bondholders are given the right to EXCHANGE Journal Entries
their bondholding into ordinary shares or other
securities of the issuing company within a BONDS WITH WARRANTS
specified period of time.
○ As simple as when it comes to PREMIUM:
convertible bonds, there is a
Cash XX
conversion from liability to equity.
● EQUITY COMPONENT = SHARE PREMIUM Bonds Payable XX
FROM BOND CONVERSION PRIVILEGE Premium on Bonds Payable XX
(BCP) (Additional Paid-In Capital from BCP) ←
Share Warrants Outstanding XX
other authors
○ This is an equity account and
specifically, this is a share premium DISCOUNT:
account. Cash XX
Discount on Bonds Payable XX
ISSUE PRICE Bonds Payable XX
LIABILITY EQUITY Share Warrants Outstanding XX
(“without”) (residual amount)
Total Amount *SWO (Bonds with ● Remember, these are your journal entries if the
WARRANTS) problem is not a CFI. The only difference is that
*BCP (CONVERTIBLE
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 when it comes to CFI, there is another account SP-BCP xx
that will be credited.
● SWO - it does not matter whether PREMIUM Discount on bonds payable xx
or DISCOUNT, you will CREDIT SWO. Ordinary share xx
Share premium-ordinary xx
CONVERTIBLE BONDS
1. You need to debit bonds payable.
a. Remember, whether debit or credit,
Cash XX whether increase or decrease, the
Bonds Payable XX bonds payable account should be
Premium on Bonds Payable XX recorded at face value.
SP-BCP XX And also, you need to decrease the corresponding
valuation account.
Cash XX 2. If that is an adjunct account, you need to debit
Discount on Bonds Payable XX premium on bonds payable, or if that is a
contra-account you need to credit discount
Bonds Payable XX on bonds payable.
SP-BCP XX a. It is to be noted that either lang po sa
dalawa. You don’t need to debit Commented [3]: Obvious naman sa journal entry na
● Again, it does not matter whether PREMIUM
premium on bonds payable and at the merong cash involved so the cash will increase. Ito
or DISCOUNT, you will CREDIT SP-BCP yung result ng pagkakabenta natin ng shares dahil nga
same time credit discount on bonds
bumili yung bondholder.
EXERCISE OF WARRANTS payable.
3. And then credit ordinary share, same concept Commented [4]: Upon exercise of warrants, wala
on the exercise of warrants. As a result ng pong effect yan sa carrying value ng bonds payable.
Cash xx Kahit ilang taon na ang lumipas, hindi na kailangang
shares issuance, the ordinary share capital will
Share warrants outstanding xx increase and it should be recorded at par or gumawa ng amort. table if you're focusing only on the
exercise of warrants because it will not affect the CV of
Ordinary share (par or stated value) xx stated value if no par value.
bonds payable.
Share premium-ordinary (BF) xx 4. And then you need to debit share premium
from bond conversion privilege upon Commented [5]: Whether warrants or conversion,
1. You need to debit cash because that is the conversion of bonds. 'yang account na yan ay magdedecrease.
result of the acquisition made by the 5. And then the balancing figure from the credit
bondholder. Commented [6]: OSC - Whether exercise ng warrants
side is the share premium-ordinary. or conversion of bonds, eto yung result ng
a. Remember, kapag may exercise of
pagkakaissue ng shares so the OSC will increase
warrants, the bondholders purchase Para mas maanalyze natin yung difference ng exercise whether exercise of warrants or conversion of bonds.
shares, so on our part, mag-iissue tayo of warrants and conversion of bonds, we will compare:
ng shares, makakareceive tayo ng Commented [7]: Base sa journal entry, whether
pera. exercise of warrants/conversion of bonds, the share
Cash CV of SWO/ Ordinary SP -
b. And another thing to remember, that Bonds SP-BCP Share Ordinary
premium will increase.
Payable Capital
should be based sa agreed Commented [8]: No cash involved.
price/exercise price/option price Exercise of

2. We will credit ordinary share because that’s

the result of shares issuance, so the ordinary
share capital will increase.
a. Remember if you are going to credit
ordinary share, that should be based
on par value or stated value if no par
value.
3. You need to debit share warrants
outstanding, that means upon the exercise of
the warrants, yung initial share warrants
outstanding na na-recognize mo upon the date
of issuance upon exercise, you need to
decrease that.
4. And then the balancing figure on your credit is
the share premium-ordinary.
CONVERSION OF BONDS
When it comes to conversion of bonds, do not debit
cash because the concept here is a conversion from
liability to equity.
Bonds payable xx
Premium on bonds payable xx
2
Warrants
Conversion
of Bonds
Sample Problem #1 (Bonds with Warrants):
On Jan. 1, 2020, Athena Corporation issued
P5,000,000 of its 10%, 7-year bonds with one non-
detachable share warrant to each P1,000 bond. Each
warrant provides for the right to purchase 20 ordinary
shares of P15 par value ordinary shares for P20 each
(exercise price or option price). The market value of
the ordinary share was P25 per share on Jan. 1, 2020.
The market value of the bonds without the warrants is
97. The bonds were sold at 104 (quoted price: ISSUE
PRICE = 5,000,000 x 1.04 = 5,200,000)
On December 31, 2022 (after 3 years), all of the
warrants were exercised.
Number of WARRANTS = *5,000 bonds x 1
warrant per bond = 5,000 warrants
*P5,000,000 / P1,000 = 5,000 bonds
Commented [9]: Since conversion from liability to
equity, ang effect niyan ay mababawasan because you
debited bonds payable and you also closed ang
corresponding adjunct account niya or contra account
niya in a form of premium or discount on bonds
payabl.e
Commented [10]: Whether warrants or conversion,
'yang account na yan ay magdedecrease.
Commented [11]: OSC - Whether exercise ng
warrants or conversion of bonds, eto yung result ng
pagkakaissue ng shares so the OSC will increase
whether exercise of warrants or conversion of bonds.
Commented [12]: Exercise Price or Option Price: Eto
yung nadiscuss kanina in case na i-eexercise yung
warrants which is equivalent sa pagbili ng shares ng
bondholders, eto yung kung magkano niya mabibili
yung bawat share.
Commented [13]: Since 104 is a quoted price, you will
just multiply that to the face value in order for you to get
the issue price of the bonds.
Commented [14]: If ever ito ay bonds without equity
characteristics, meaning this is not a CFI, the whole
5.2M should be attributable to liability.
However, since this is a CFI, we need to bifurcate the
5.2M

Number of SHARES = 5,000 warrants x 20 shares
per warrant = 100,000 ordinary shares
TOTAL ISSUE PRICE = 5,200,000
LIABILITY EQUITY
(“without”) (residual amount)
DEBT COMPONENT EQUITY COMPONENT
5,000,000 x 0.97 = 5,200,000 - 4,850,000 =
4,850,000 350,000
Issue price of the Debt Component only
(Liability)
Face Value of the Bonds
Discount on Bonds Payable
QUESTIONS:
1. Prepare the journal entry to record the
issuance of the bonds.
ISSUANCE OF BONDS
Jan. 1, 2020
Cash (total issue price) 5,200,000
Discount on Bonds Payable (BF) 150,000
Bonds Payable (face value)
Share Warrants Outstanding
(amount allocated to equity)
2. Prepare the journal entry to record the
exercise of the warrants.
EXERCISE OF WARRANTS
Dec. 31, 2022
Cash (equivalent sa pagbili ng shares 2,000,000
ng bondholder) (100,000 shares x
P20)
Share warrants outstanding (since 350,000
na-exercise na yung warrants, eto
yung account na kailangan
magdecrease) (350,000 x 100%)
Ordinary share (par or stated
value) (as a result of issuance of
shares the ordinary share capital
will increase (100,000 shares x
P15)
Share premium-ordinary (BF)
3. How much should be taken to equity on the
date of issuance? P350,000
4. How much from the issue price should be
reported as liability? P4,850,000
5. How much should be credited to Share
Premium account upon exercise of the
warrants? P850,000
6. Assuming that 60% of the warrants were
exercised at a time when the market value of
the share is P50 (hindi gagamitin, irrelevant),
how much should be credited to Share Commented [15]: Meron tayong 100,000 ordinary
Premium account? P510,000 (P850,000 x shares na pwedeng i-issue or ibenta.
60%)
Commented [16]: Eto ang binibigyan ng priority.
- Same lang sila ng tanong ng #5, the difference Applying the accounting equation, the capital in your
is that yung #5, lahat ng warrants inexercise, accounting equation represents the net assets or the
while yung #6, partial exercise lang ng residual assets kaya ang equity po diyan ay residual
warrants. amount lang.
- Bakit nagkakamali ang mga students dito?
Commented [17]: Another thing, usually mababasa
Hindi nila alam ang dapat gawin doon sa P50 mo sa problem ay ang keyword na "without". Yun kasi
na given sa #6 na tanong. diba yung nagiging basis natin para malaman natin
- Based sa discussion kanina, yung cash naman kung magkano yung amount which should be allocated
na marereceive natin, yung basis natin doon ay to liability, like "the market value of the bonds without
yung agreed price/exercise price/option price.
4,850,000 the warrants". Pag dating sa convertible bonds,
- Sinabi dito nung time na inexercise, the market mababasa mo dyan "the market value of the bonds
without the conversion features." So yun po ang ating
value is P50.
5,000,000
- Sa part ng bondholder, hindi naman nila ito basis natin para malaman kung magkano ang para sa
liab.
bibilhin ng P50 sa’tin, kundi based na rin doon
150,000
sa naging agreed price na P20. Commented [23]: inissue ang bonds at 103, so that is
- So that means, this is irrelevant. in a form of a quoted price.
Commented [24]: so kung annual ang bayaran ng
EXERCISE OF WARRANTS interest, so 5 periods for the purpose of computing the
PV factor.
Dec. 31, 2022
Cash (60,000 shares x P20) 1,200,000 Commented [18]: If all the warrants will be exercised,
the total number of shares na ma-issue mo sa
60% * 100,000 = 60,000 shares bondholder is 100,000.
Share warrants outstanding 210,000
(350,000 x 60%) Since nakalagay naman, all the warrants were
exercised, so base sa computation natin, it should be
Ordinary share 900,000
(60,000 shares x P15)
100,000 shares x P20.
5,000,000
350,000 Share premium-ordinary (BF) 510,000 Commented [19]: Yan yung agreed price or tinatawag
- Parang i-60% mo lang lahat nung unang entry natin na exercise price or option price.
Commented [20]: Initially, you recognize share
warrants outstanding amounting to 350,000, kahit
Sample Problem #2 (Convertible Bonds): lumipas na yung 3 taon, remember na hindi yan
maaapektuhan because di ka nag-aamortize ng equity
On January 1, 2020, Uranus Company issued account.
P5,000,000, 8% convertible bonds at 103. Interest is
So 350,000 pa rin yan after 3 years.
payable annually every December 31 and the bonds
mature on December 31, 2024 (ang life ng bonds niya Ang concern mo na lang kung lahat nga ba yan
is 5 years). Each P1,000 bond is convertible into 5
kailangan isarado.
shares of P100 par value ordinary share. Without the
conversion feature, the bonds would have sold to Commented [21]: Kasi lahat ng warrants ay
inexercise. So lahat ng balance ng 350,000 should be
yield 10% (effective rate)
closed.
1,500,000 On December 31, 2022 (after 3 years), after paying the Commented [25]: kaya 100%
periodic interest, all of the bonds were converted.
Commented [22]: katabi ng word na "ordinary shares"
Commented [26]: ang lahat ng bonds na macoconvert
Number of SHARES = 5,000 bonds x 5 shares per ay 25,000 ordinary shares.
850,000 bond = 25,000 ordinary shares
Commented [27]: Eto ang binibigyan ng priority.
*P5,000,000 / P1,000 = 5,000 bonds
Applying the accounting equation, the capital in your
TOTAL ISSUE PRICE accounting equation represents the net assets or the
5,000,000 x 1.03 = 5,150,000 residual assets kaya ang equity po diyan ay residual
amount lang.
LIABILITY EQUITY
(“without”) (residual amount) Commented [28]: Another thing, usually mababasa
mo sa problem ay ang keyword na "without". Yun kasi
DEBT COMPONENT EQUITY COMPONENT diba yung nagiging basis natin para malaman natin
kung magkano yung amount which should be allocated
4,620,820 5,150,000 - 4,620,820 = to liability, like "the market value of the bonds without
529,180 the warrants". Pag dating sa convertible bonds,
mababasa mo dyan "the market value of the bonds
ISSUE PRICE OF THE DEBT/LIABILITY without the conversion features." So yun po ang ating
COMPONENT ONLY: basis natin para malaman kung magkano ang para sa
liab.
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 ● Pinakamasarap sagutan, kasi yan ay matik na
PV of the cash flows using 10% for 5 periods. 0.
● Why is the answer zero?
Present value of FACE 5,000,000 0.6209 3,104,500 ○ One of the evidences to justify that the
VALUE (MATURITY answer is zero, of course your journal
VALUE) entry. So kung babalikan natin yung
Present value of (Periodic) 400,000 3.7908 1,516,320 journal entry, hahanapin natin yung
INTEREST (5,000,000 x 8%) account na pwedeng pumasok sa P/L.
Issue Price (LIABILITY) 4,620,820 ○ You debited B/P and you closed the
corresponding contra account (disc-
bp). So yung dalawa na yun, yun yung
Issue price of the Liability/Debt Component only 4,620,820 CV ng bonds payable, at syempre alam
naman natin na liability yun.
Face Value of the Bonds 5,000,000 ○ You credited ordinary share, which is
Discount on Bonds Payable 379,180 absolutely an equity account, you
credited share premium ordinary which
1. Prepare the journal entry to record the is an equity account pa rin, you debited
issuance of the bonds. SP-BCP, that is not a P/L item, that is a
decrease from an equity account.
Jan. 1, 2020 ○ Based on the journal entry, wala kang
Cash (total issue price) 5,150,000
account na ang nature niya ay P/L.
○ That’s why there is no gain or loss on
Discount on Bonds Payable (BF) 379,180
conversion that should be reported in
Bonds Payable (face value) 5,000,000
P/L.
SP-BCP (equity component) 529,180 ○ Kaya matik na ang sagot mo jan ay
zero.
2. Prepare the journal entry to record the
conversion of the bonds. 7. Assuming that only P1,000,000 face value of Commented [29]: Kailangan na natin gumawa ng
the bonds were converted on Dec. 31, 2022, amortization table to update the CV of bonds after 3
Date Nominal Effective Discount Amortization how much should be credited to share years.
Interest Interest Amortization Cost
(8%) (10%) (NI - EI) (AC + DA) premium account upon conversion?
(AC X EI) P571,098 Kasi nga diniscuss natin kanina kapag conversion of
1/1/20 - - - 4,620,820
bonds, it affects the CV of bonds payable.
12/31/20 400,000 462,082 62,082 4,682,902 ● Partial conversion lang.
We need to update the CV of bonds payable on Dec.
1231/21 400,000 468,290 68,290 4,751,192 ● P1,000,000 of the P5,000,000 face value of the 31, 2022.
12/31/202 400,000 475,119 75,119 4,826,311 bonds lang ang naconvert.
● Same pa rin yung amort table pero yung CV of
bonds nung Dec. 31, 2022, we need to compute
CV of bonds CONVERTED = how much yung CV of the bonds converted.
4,826,311 x 100% = 4,826,311 Commented [30]: Kasi nakalagay sa problem, "all of
Date Nominal Effective Discount Amortization the bonds were converted".
Interest Interest Amortization Cost
Dec. 31, 2022 (8%) (10%) (NI - EI) (AC + DA)
Bonds payable (hindi yung CV kasi 5,000,000 (AC X EI)
whether debit/credit, whether 1/1/20 - - - 4,620,820
increase/decrease, the bonds payable
12/31/20 400,000 462,082 62,082 4,682,902
account should be recorded as FV)
SP-BCP (529,180 x 100%) 529,190
1231/21 400,000 468,290 68,290 4,751,192 Commented [31]: Initially, you recognize SP-BCP
12/31/202 400,000 475,119 75,119 4,826,311 amounting to 529,180. Kahit 3 taon na ang lumilipas, di
Discount on bonds payable 173,689 pa rin yan magbabago because we do not amortize
(5,000,000 - 4,826,311) equity account.
Ordinary share 2,500,000 CV of bonds CONVERTED =
(25,000 shares x P100) 4,826,311 x 20% = 965,262 As of Dec. 31, 2022, that remains as 529,180.
Share premium-ordinary (BF) 2,855,491
1,000,000 / 5,000,000 = 20% Ang tanong na lang lahat ba yan ay kailangan
isarado?
3. How much should be taken to equity on the
date of issuance? P529,180 Bonds payable (kasi 1,000,000 lang 1,000,000 The answer is YES if all the bonds are converted.
ang naconvert)
4. How much from the issue price should be SP-BCP (529,180 x 20%) 105,836 Since malinaw naman na lahat ng bonds ay icoconvert
reported as liability? P4,620,820 edi lahat yan dapat isarado natin.
Discount on bonds payable 34,738
(1,000,000 - 965,262) Commented [32]: Pertaining to the 1,000,000 face
5. How much should be credited to Share value, ang CV nyan is 965,262, so yung 34,738, yan pa
Premium account upon conversion of the Ordinary share 500,000
(5,000 shares x P100) (25,000
yung unamortized or balance ng disc-bp before
bonds? P2,855,491 shares x 20%) conversion pertaining only to the 1 million.
Share premium-ordinary (BF) 571,098 Commented [33]: Remember, kapag lahat ng bonds
6. How much is the gain or loss on conversion ay naconvert, you will issue 25,000 shares.
should be reported in profit or loss? P-0-
Since 20% lang ang naconvert so 25,000 x 20%
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