FINANCIAL INSTRUMENT COMPOUND FINANCIAL INSTRUMENT

PAS 32, paragraph 11, defines a financial instrument as any PAS 32, paragraph 28, defines a compound financial instrument
contract that gives rise to both a financial asset of one entity and as a financial instrument that contains both a liability and an
a financial liability or equity instrument of another entity. equity element from the perspective of the issuerto

CHARACTERISTICS OF A FINANCIAL INSTRUMENt In other words, one component of the financial instrument meets
the definition of a financial liability and another component of
a. There must be a contract. the financial instrument meets the definition of an equity
b. There are at least two parties to the contract. instrument.
c. The contract shall give rise to a financial asset of one party
and financial liability or equity instrument of another party. The common examples of compound financial instrument are:

a. Bonds payable issued with share warrants

b. Convertible bonds payable

A financial liability is a contractual obligation: ACCOUNTING FOR COMPOUND INSTRUMENT

a. To deliver cash or other financial asset to another entiy. The issuer of a financial instrument shall evaluate the terms of
b. To exchange financial instruments with another entity under the instrument whether it contains both a liability and an equity
conditions that are potentially unfavorable. component.

If the financial instrument contains both a liability and an equity

Financial liabilities component, PAS 32 mandates that such components shall be
accounted for separately.
a. Trade accounts payable
The approach in accounting for a compound financial instrument
b. Notes payable is split accounting.

c. Loans payable Split accounting means that the consideration received from the
issuance of the compound financial instrument shall be
d. Bonds payable allocated between the liability and equity components.

The fair value of the liability component is first determined.

Nonfinancial liabilities The fair value of the liability component is then deducted from
the total consideration received from the issuance of the
a. Deferred revenue and warranty obligations are not financial compound financial instrument.
liabilities because the outflow of economic benefit is the delivery
of goods and services rather than a contractual obligation to pay The residual amount is allocated to the equity component.
cash.

b. Income tax payable is not a financial liability because it is

statutory or imposed by law and noncontractual. BONDS PAYABLE ISSUED WITH SHARE WARRANTS

c. Constructive obligations are not financial liabilities because When the bonds are sold with share warrants, the bondholders
the obligations do not arise from contracts. 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
EQUITY INSTRUMENT share warrants.

An equity instrument is any contract that evidences a residual Share warrants attached to bonds payable may be detachable or
interest in the assets of an entity after deducting all of the nondetachable. Detachable warrants can be traded separately
liabilities. from the bond and nondetachable warrants cannot be traded
separately.
Equity instruments include ordinary share capital, preference
share capital and warrants or option. 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 ALLOCATION OF ISSUE PRICE

The bonds are assigned an amount equal to the market value of The economic effect of issuing convertible bonds payable is
the bonds ex-warrants, regardless of the market value of the substantially the same as issuing simultaneously bonds payable
share warrants. with share warrants.

The residual amount or remainder of the issue price shall then The bonds are assigned an amount equal to the market value of
be allocated to the share warrants. the bonds without the conversion privilege.rit

The residual approach is based on the definition of an equity The residual amount or remainder of the issue price shall then
instrument as a contract that evidences a residual interest in the be allocated to the conversion privilege or equity component.
assets of an entity after deducting all of the liabilities.
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
MARKET VALUE OF BONDS WITHOUT WARRANTS UNKNOWN the present value of future interest payments using the effective
or market interest rate for similar bonds payable without
In the absence of market value of bonds without the warrants,
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 the future interest payments using the effective or market
interest rate for similar bonds payable without the share
CONVERSION OF BONDS PAYABLE
warrants.
If bonds are converted into share capital I of the
issuing entity the accounting problem is the
CONVERTIBLE BONDS PAYABLE determination of a value to be assigned to the share
An entity frequently makes its bond issue more attractive to capital issued.ng tái xanky
investors by making the bonds convertible.
The carrying amount of the bonds is the measure of
Convertible bonds are bonds which give the holders the right to the share capital issued because the carrying
convert their bondholdings into share capital or other securities amount is the "effective price" for the shares issued
of the issuing entity within a specified period of time.
as a result of the conversion.
Often, the conversion privilege becomes less attractive as time
goes by. Application Guidance 32 of PAS 32 provides that
there is no gain or loss on conversion at maturity.
When convertible bonds are issued at a premium or discount,
amortization period is up to the maturity date instead of the The reason is that the convertible bond is viewed in
conversion date because it is impossible to predict, if at all, that
substance as an equity and the conversion is really
the conversion privilege will be exercised.
an exchange of one type of equity capital for another.

Any cost incurred in connection with the bond

Accounting problems arise in two situations, namely: conversion shall be deducted from share premium
a. When the convertible bonds are originally issued arising from the bond conversion.

b. When the convertible bonds are converted 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
ORIGINAL ISSUANCE minus unamortized discount on bonds payable and
bond issue cost.
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.
Accounting procedures

a. The amortization of discount and premium on

bonds payable 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
unąmortized premium and discount on bonds
payable.

If only a portion of the bonds is converted, the

unamortized premium or discount on bonds payable
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.