Top Ad unit 728 × 90

How to Account for Compound Financial Instruments (IAS 32) with Example in Excel

What is a compound financial instrument?

Standard IAS 32 defines compound financial instrument as a non-derivative financial instrument that, from the issuer’s perspective, contains both liability and an equity component.

ie. that the issuer of this instrument cannot simply show it purely as a liability or purely as an equity because this instrument contains the both.

For Example: If a bond convertible into a fixed number of  shares (the bond holder can get paid either by cash at maturity or exchange this bond for some fixed number of issuer’s shares);

The Two components would be; 
Liability is  issuer’s obligation to pay interest or coupon and, to redeem the bond in cash at maturity potentially.
Equity is the holder’s call option for issuer’s shares (ie. holder can chose to get fixed amount of shares and not getting fixed amount of cash).

Another Example:

Accounting treatment in issuer’s financial statements

Steps to be followed on initial recognition;
  • Step 1: Identify the various components of the compound financial instrument.
    That’s obvious. The issuer must clearly identify what the liability element is and what the equity element is.
  • Step 2: Determine the fair value of the compound financial instrument as a whole.
    Basically this shouldn’t be any problem, because if the transaction happens under market conditions, then the fair value of the instrument as a whole equals to cash received in return for the instrument.
  • Step 3: Determine the fair value of the liability component.
    The fair value of the liability component can be determined at fair value of a similar liability that does NOT have any associated equity conversion feature. So for example, the fair value of the liability component of the convertible bond equals to fair value of the bond with the same parameters (maturity, coupon rate, etc.) but without the option to convert into issuer’s shares.
  • Step 4: Determine the fair value of the equity component.
    The equity component is determined simply as the fair value of the compound financial instrument as a whole (step 2) less the fair value of the liability component (step 3).

    So the Double Entries would be;

    Dr Cash
                        750,000
    azreenm.tk To Liability- Convertible Bonds                657,746


    Equity- Convertible Bonds
                      92,254 
How to Account for Compound Financial Instruments (IAS 32) with Example in Excel Reviewed by Azreen Mohamed on Tuesday, October 21, 2014 Rating: 5

No comments:

All Rights Reserved by Let's Learn IFRS © 2014 - 2015
Developed by Azreen, Designed by Lets Learn IFRS

Contact Form

Name

Email *

Message *

All Rights Reserved. Let's Learn IFRS. Powered by Blogger.