00 00 00 ng CHAPTER 10 COMPOUND FINANCIAL INSTRUMENT Problem 10-1 (AICPA Adapted) At year-end, Fort Company issued 5,000 8%, 10-year bonds, P1,000 face amount with detachable share warrants at 110. Each bond carried a detachable warrant for ten ordinary shares of Fort Company at a specified option price of P25 per share. The par value of the ordinary share is P20. Immediately after issuance, the market value of the bonds without the warrants was P5,400,000 and the market value of the warrants was P600,000. What is the carrying amount of bonds payable at year-end? a. 5,000,000 b. 4,950,000 ce. 4,900,000 d. 5,400,000 Solution 10-1 Answer d Issue price of bonds payable ~ equal to market . value without the warrants 5,400,000 The issue of bonds payable with share warrants is accounted for as acompound financial instrument.’ Share warrants attached-to a bond may be detachable or nondetachable: Detachable warrants can be traded separately fr nondetachable warrants cannot be edica eart-ty the bond and 139issuer of a compound h 28, mandates that the issu ‘ te shall classify the liability and equity component separately. ‘This standard does not differen * js detachable or nondetachable. ‘Whether detachable or nondetachable, the warrants have a value and therefore shall be accounted for separately. PAS 32, paragraph 31, further provides that equity instruments are instruments that evidence a residual interest in the assets of the entity after deducting all of its liabilities. tiate whether the equity component Accordingly, the bonds are assigned an amount equal to the “market value of the bonds ex-warrants” regardless of the market value of the warrants. ‘The remainder of the issue price shall then be allocated to the warrants. Issue price of bonds with warrants (5,000,000 x 110) 5,500,000 Market value of bonds without warrants 5,400,000 Residual amount allocated to warrants ~ equity component __ 100,000 Entry to record the issue of bonds payable with share warrants Cash 5,500,000 Bonds payable a 5,000,000 Premium_on bonds payable “400,000 Share warrants outstanding 100,000 Exercise of share warrants by the bondholders Cash (5,000 x 10 x P25) 12 Share warrants outstanding "Tonc00 Share capital (50 x 10 x P20) . 1,000,000 Share premium °350,000 140 The pre value of gece < ° 5 o erp ge ¢ + es Ppp peop opera aePoung Ponent Ponent ‘Value ents are € entity ‘market ralue of d to the 500,000 400,000 arrants 000,000 400,000 100,000 000,000 350,000 h Problem 10-2 (AICPA Adapted) Atthe beginning of current year, : face amount, 5-year bonds xt 1 a Company issued P5,000,000 Each P1,000 bond was issued with 50 detach: ) able share warrants, each of which entitled the bondholder to purchase one ordinary share ofS par value at P25. Immediately after issuance, the market value of each warrant was PS, ‘The stated interest rate on the bonds is 11% payable annually every December 31. However, the prevailing market rate of interest for similar bonds without warrants is 12%. The present value of 1 at 12% for 5 periods is 0.57 and the present value of an ordinary annuity of | at 12% for 5 periods is 3.60. 1, What is the initial carrying amount of the bonds payable? ),000 b. 4,830,000 ce. 5,000,000 d. 4,380,000 2. What amount should be recorded initially as discount or premitim on bonds payable? a. 170,000 discount b. 450,000 premium ¢. 450,000 discount d. 800,000 discount ¥ nas 3. What amount should be reported as equity component arising from the issuance of bonds payable? a. 450,000 b. 500,000 c. 620,000 a 0 4. What amouint should be recorded as share premium if all of the warrants are exercised? 1,250,000 2,500,000 5,000,000 1. 5,620,000 ae oP 141Solution 10-2 Question | Answer b Question 3 Answer ¢ Question 2 Answer a Question 4 Answer d PV of principal (5,000,000 x 57) 2,850,000 PV of annual interest payments (550,000 x 3.60) 1,980,000 (Question 1) 4,830,000 Total present value of bonds payable Bonds payable 5,000,000 Present value of bonds payable 4,830,000 Discount on bonds payable (Question 2) 170,000 Ifthe maket value of the bonds without warrants is unknown, the amount allocated to the bonds is equal to the present value of the principal bond liability plus the present value of future interest payments using the market rate of interest for similar bonds without the warrants. Issue price of bonds with warrants (5,000,000 x 109%) 5,450,000 Present value of bonds payable 4,830,000 Residual amount allocated to warrants (Question 3) 620,000 = Journal entry to record the issue of bonds with share warrants Cash Discount on bonds payable acon Bonds payable " 100,000 Share warrants outstanding *$20,000 3 Question 4 Jou rnal entry to record the exercise of all of the share warrants Cash (5,000 x 50 x P25) . Share warrants outstansing 6,250,000 Share capital (250,000 x PS) 620,000 Share premium 1,250,000 5,620,000 a Pr At! 129 Ina wal P5C The of tl,000 ,000 rants 1,000 9,000 a | Problem 10-3 (AICPA Adapted) Atthe beginning of current year, Case Company issued P5,000,000 of 12% nonconvertible 5-year bonds at 103. 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. The quoted market value of each warrant was P4. The market value of the bonds ex-warrants at the time of issuance is 95. 1, What is the carrying amount of the bonds payable? a. 5,000,000 b. 4,750,000 ce. 5,150,000 d. 4,550,000 2. What amount of the proceeds from the bond issue should be recognized as an increase in shareholders’ equity? a. 600,000 b. 300,000 c. 200,000 d. 400,000 Solution 10-3 Question |. Answer b Question 2 Answer d Issue price of bonds with warrants (5,000,000 103%) 5,150,000 Market value of bonds without warrants (5,000,000 x 95%) 4,750,000 Residual amount allocated to warrants — equity component — 400,000 143Problem 10-4 (IAA) Moriones Company issued P5,000,000 face amount 12% convertible bonds at 110 at the beginning of current year. The bonds pay interest semiannually on January 1 and July 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 ce. 150,000 d. 0 Solution 10-4 Answer a The issue of convertible bonds payable is also accounted for asa compound financial instrument Accordingly, PAS 32, paragraph 29, mandates that the original issuance of convertible bonds payable shall be accounted for as partly liability and partly equity. The liability component is equal to the market value of the bonds without the conversion privilege. ‘The equity component is the remainder or residual of the issue price of the bonds with conversion privilege. Issue price of bonds with conversion privilege (5,000,000 x 110) 5,500,000 Market value of bonds without conversion privilege (5,000,000 x 103) 5,150,000 Residual amount allocated to conversion privilege 350,000 350,008 Actually, the journal entry to record the issuance of the convertible bonds payable is: Cash Bonds payable aati 5,000,000 Premium bonds payable "150, Share premium — conversion privilege 350,000 144 probl At th conve are iss Intere Each t shares When simila The p! value. What ¢ issuan al 1,€ § g aege Solutic PV of j PY of Total p Issue p Present Equity, The lia Withou Ifthe n is unk Princip Paymer ‘con% 10 ity le? Sa nal ras nds rice Problem 10-5 (LAA) 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 PS. 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 reported as equity component of the original issuance of the convertible bonds payable? a’ 1,150,000 b. 1,650,000 c. 891,000 d. 391,000 Solution 10-5 Answer c PV of principal ($,000,000 x .77) 3,850,000 PV of annual interest payments (300,000 x2.53) 759,000 Total present value of bonds 4,609,000 Issue price of convertible bonds (5,000,000 x 110) 5,500,000 _ Present value of bonds 4,609,000 Equity component — Share premium 891,000 The liability component is equal to the market value of the bonds without conversion privilege. If the market value of the bonds without the conversion privilege is unknown, the amount is equal to the present value of the Principal bond liability plus the present value of t ‘the future interest Payments using the market rate of interest for similar bonds without the conversion privilege. 145,Problem 10-6 (AICPAAdapted) fie | any had outstanding share capital with par value of on 000 on a 12% convertible bond payable in the 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 P20 par value in exchange for each P1,000 bond. On June 30, the holders of bonds with face amount of P5,000,000 exercised the conversion privilege. The market price of the bonds ~ on that date was P1,100 per bond and the market price of the share was P30. The total unamortized bond discount at the date of conversion was P500,000. The share premium from conversion privilege has a balance of P2,000,000 on June 30. ‘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 ce. 3,000,000 d. 1,750,000 Solution 10-6 Answer d Bonds payable Discount on bonds payable 10,000,000 - . 500,000) Carrying amount ( ee Carrying amount converted (5/' Applicable share premium fick eee ‘ 4,750,000 (5/10 x 2,000,000) ~ Privilege Total consideration 4,000,000 Par value of shares issued 5,750,000 (5,000 x 40 = 200,000 sharesx 20) 4,000,000 Share premium from conversion eat 1,750,000 146ie of fae Ong 000 000 nds * the asa fthe 300 \e 8 3 90! = eS S \s® 3\ Problem 10-7 (AICPA Adapted) Clay Company had P600,000 convertible 8% bonds payable outstanding on June 30. Each P1,000 bond was convertible into 10. ordinary shares of PSO 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 these bonds was P12,000 at the date of conversion. No equity component was recognized when the bonds were originally issued. 1. What amount should be recorded as increase in share capital as a result of the bond conversion? a. 300,000 b. 306,000 c. 450,000 d.. 600,000 2. What amount should be recorded as increase in share premium as aresult of the bond conversion? (312,000 306,000 162,000 12,000 aeoP Solution 10-7 Question | Answer a Question 2 Answer a Bonds payable 600,000 Premium on bonds payable 12,000 Carrying amount 612,000 Ordinary shares issued at par value (6,000 shares x 50) 300,000 Share premium — 312,000 “147nn Ea Problem 10-8 (AICPA Adapted) ding 10%, P1,000,000 face Atyear-end, Cey Company had outstanding ait convertible bonds payable maturing in three years. Interest is payable on June 30 and December 31. Each P1,000 bond is convertible into 50 shares of P10 par value. Tthe unamortized premium on bonds payable was P60,000 at year-end. At year-end, 400 bonds were converted when Cey’s share hada market price of P24. The entity incurred P4,000 in connection with the conversion. No equity component was recognized when the bonds were originally issued. What amount should be recorded as share premium from the issuance of shares as a result of the bond conversion at year-end? a. 176,000 b. 220,000 c. 276,000 d. 280,000 Solution 10-8 Answer b Bonds payable Premium on bonds payable : oe Carrying amount 7,060,000 cont eS Carrying amount Converted (400/1,000 x 1,060,000) 424,000 of shares issued (400 x 50x P10) 200,000 Share premium Fra 000 Conversion expenses 224,00 Net share premium ‘ mod 220, sS—ace 00 D at ida vith ere the Problem 10-9 (AICPA Adapted) Isabel Company had outstanding share capital with par value of - P50,000,000 and a 12% convertible bonds payable in the face amount ofP10,000,000. Interest on the bond is payable annually on December 31. The conversion clause entitled the bondholders co 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 P1,100 per bond and the market price of the share was P30. The premium on bonds payable at the date of convérsion was 3,000,000. The paid in capital from conversion privilege has 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 ¢. 600,000 d. 900,000 Solution 10-9 Answer d Under IFRS, the bond conversion is recorded at the carrying amount of the bonds converted. Bonds payable 10,000,000 Premium on bonds payable 3,000,000 Carrying amount 13,000,000 Carrying amount converted (2,000 / 10,000 x 13,000,000) 2,600,000 Applicable paid in capital from conversion privilege (2,000 / 10,000 x 1,500,000) 300,000 Total consideration 2,900,000 Par value of shares issued (2,000 x 50 = 100,000 shares x 20 par) (2,000,000) Share premium from bond conversion 149Problem 10-10 (AICPA Adapted) ing interest and amortization. Andi Company converted ms sO oa of 2% convertible bonds into 50,000 shares of P50 par valve. On the conversion date, the carrying amount of the bonds payable was P6,000,000, the market value of the bonds P6,500,000 and the share was publicly trading at 150. ‘The entity incurred P200,000 in connection with the bond conversion. When the bonds were originally issued, the equity component was recorded at P2,000,000. ‘What amount of share premium should be recorded asa result of the bond conversion? a. 6,000,000 b. 5,800,000 ce 5,300,000 d. 5,500,000 Solution 10-10 Answer c Bonds payable 5,000,000 Premium on bonds payable 1,000,000 Carrying amount 6,000,000 Share premium from conversion privilege 2,000,000 Total consideration 8,000,000 Par value of shares issued (50,000 x 50) 2,500,000 Share premium from bond conversion 5,500,000 Conversion cost (200,000) Net share premium 5,300,000 Bonds payable 5,000,000 Premium on bonds payable 1,000,000 Share premium ~ conversion privilege 2,000,000 . Share capital 2,500,000 Share premium — issuance 5,500,000 Share premium — issuance 200,000 Cash 200,000 bes 6h th iin Oe mek ee sy wH anogn onProblem 10-11 ([AA) Young Company issued 5,000 convertible bonds at the beginning of the current year. The bonds had a four-year term with a stated rate of interest of 6%, and were issued at par with a face amount of P1,000 per bond. Interest is payable annually on December 31. Each bond is convertible into 50 ordinary shares with a par value of P10. The market rate of interest on similar nonconvertible bond is 9%. At the issuance date, the amount of P485,000 was credited to share premium from conversion privilege. The bonds were not converted and instead, the entity paid off the convertible bondholders at maturity. What amount should be recorded as gain or loss on the full payment of the convertible bonds at maturity? . a. 300,000 gain b. 485,000 loss c. 485,000 gain d. 0 Solution 10-1] Answer d To record the issuance of the convertible bonds: Cash 5,000,000 Discount on bonds payable 485,000 Bonds payable 5;000,000 Share premium= conversion privilege 485,000 To record the settlement of the convertible bonds at maturity date: Bonds payable 5,000,000 Interest expense (6% x 5,000,000) 300,000 Cash 5,300,000 Share premium — conversion privilege 485,000 Share premium — issuance 485,000 isiProblem 10-12 ([AA) OnJ. 1,2022, Arlene Company issued convertible bonds with a g fare amnotat ‘of P5,000,000 for P6,000;000. zs bonds are convertible into 50,000 shares with P100 par value, The bonds have a 5-year life with 10% stated interest rate payable annually every December 31. Q The fair value of the convertible bonds without conversion option is Ci computed at P5,399,300 on January 1, 2022. Fa On December 31, 2024, the convertible bonds were not ‘converted Pr but fully paid for P5,550,000. a On such date, the fair value of the bonds without conversion privilege is ~ P5,400,000 and the carrying amount is P5,178,300. Iss Fa 1. Whatis the carrying amount of the bonds payable on January 1, * 20229 Na “ SH a. 5,000,000 b. 6,000,000 o c. °5,399,300 | To’ d. 5,500,000 | Pay 2. What is the premium on bonds payable on January 1, 2022? | Eq a. 1,000,000 b. 500,000 Ca c. 399,300 | Pay a 0 * Lo: 3. What amount should be recorded as equity c i | issuance of bonds payable on Tauaiy et ane rising fron | Jor a. 500,000 B b. 800-700 Pre & 0,000 d. 0 | re 4. What amount should be recorded as loss on the — extinguishm oy the convertible bonds payable on December 31, 2024? sia Tnte a. 221,700 b, 371,700 ¢, 150,000 Sha d, 9 152 . . 3of Solution 10-12 Question 1 Answer c Carryi ng amount of bonds payable equal to fair value without conversion privilege on January 1, 2022 Question 2 Answer c Carrying amount of bonds payable Face amount Premium on bonds payable — January 1, 2022 Question 3 Answer b Issue price Fair value of bonds without conversion option Share premium — conversion privilege Question 4 Answer a Total payment ~ December 31, 2024 Payment applicable to bonds payable Equity component Carrying amount of bonds payable ~ December 31, 2024 Payment applicable to bonds payable Loss on extinguishment Journal entries on December 31, 2024 Bonds payable . Premium on bonds payable Share premium — conversion privilege Loss on extinguishment Cash Interest expense (10% x 5,000,000) Cash ‘ Share premium — conversion privilege Share premium — issuance (600,700— 150,000) 153 5,000,000 178,300 150,000 221,700 500,000 450,700 5,399,300 5,399,300 5,000,000 399,300 6,000,000 5,399,300 600,700 5,550,000 (5,400,000) 10,000 5,178,300 (5,400,000) 5,550,000 450,700