Compound Financial Liability

GIALOGO, JESSIE LYN
1. What is a 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.
2. What are the characteristics of a financial 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 liability and an equity component,
PAS 32, paragraph 29, 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.
3. Give examples of financial instrument.
The common example of compound financial instrument are as follows:
a. Bonds payable issued with share warrants
b. Convertible bonds payable.
4. What is a financial liability?

- Financial liabilities may usually be legally enforceable due to an agreement
signed between two entities. But they are not always necessarily legally
enforceable.
- They can be based on equitable obligations like a duty based on ethical or
moral considerations or can also be binding on the entity as a result of a
constructive obligation which means an obligation that is implied by a set of
circumstances in a particular situation, as opposed to a contractually based
obligation.
- Financial liabilities basically include debt payable and interest payable which
is as a result of the use of others’ money in the past, accounts payable to other
parties which are as a result of past purchases, rent and lease payable to the
space owners which are as a result of the use of others’ property in the past
and several taxes payable which are as a result of the business carried out in
the past.
5. Give examples of financial liability.

- A contractual obligation to deliver cash or another financial asset to another
entity or to exchange financial assets or financial liabilities with another entity
under conditions that are potentially unfavorable to the entity; also a contract
that will or may be settled in the entities own equity instrument and is either a
non-derivative for which the entity may be obliged to deliver a variable.
6. What is an equity instrument?
- A contract that evidences a residual interest in the assets of an entity after
deducting all of its liabilities.
7. Give examples of equity instrument?

Examples of equity instruments include –
- non-puttable ordinary shares,
- some puttable instruments (see paragraphs 16A and 16B of IAS 32),
- some instruments that impose on the entity an obligation to deliver to another
party a pro rata share of the net assets of the entity only on liquidation (see
paragraphs 16C and 16D of IAS 32),
- some types of preference shares (see paragraphs AG25 and AG26 of IAS 32),
and
- Warrants or written call option that allow the holder to subscribe for or
purchase a fixed number of non-puttable ordinary shares in the issuing entity
in exchange for a fixed amount of cash or another financial asset.
8. What is a compound financial instrument?

- A financial instrument that contains both liability component and equity
component.
9. Explain the accounting for a compound financial instrument.

- Before outlining the accounting treatment let me stress that the accounting
treatment in issuer’s financial statements significantly differs from accounting
treatment in holder’s financial statements.
- Issuer is someone who creates the compound financial instrument—we can
equally call him “borrower” because he raises money by issuing compound
financial instrument.As opposite, holder is someone who acquires compound
financial instrument and we can call him “lender”.
10. What are the common examples of compound financial instrument?

- A bond convertible into a fixed number of issuer’s shares
When the bond is convertible into shares, it means that the bond holder can
get paid either by cash at maturity or exchange this bond for some fixed
number of issuer’s shares. It is a compound financial instrument because it
contains 2 elements:
 a liability = issuer’s obligation to pay interest or coupon and
POTENTIALLY, to redeem the bond in cash at maturity (or a
conventional loan); and
 an equity = the holder’s call option for issuer’s shares (or in other
words, holder can chose to get fixed amount of shares instead of fixed
amount of cash).
- A preference share redeemable at issuer’s discretion with mandatorily paid
dividends
If an issuer issuers such a share, he must pay dividends each year (or in line
with terms of the share), but the issuer can also chose whether and when he
redeems the share. Again, this is a compound financial instrument with 2
elements:
 a liability = issuer’s obligation to pay dividends; and
 an equity = the issuer’s call option for own shares (or in other words,
issuer can chose to pay fixed amount of cash for fixed amount of
shares).

Compound Financial Liability

Uploaded by

Copyright:

Available Formats

Compound Financial Liability

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Compound Financial Liability

Uploaded by

Copyright:

Available Formats

GIALOGO, JESSIE LYN

1. What is a financial instrument?

2. What are the characteristics of a financial instrument?

4. What is a financial liability?

5. Give examples of financial liability.

7. Give examples of equity instrument?

8. What is a compound financial instrument?

9. Explain the accounting for a compound financial instrument.

10. What are the common examples of compound financial instrument?

You might also like