INTERMEDIATE ACCOUNTING 3

COMPOUND
FINANCIAL
INSTRUMENTS
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JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

COMPOUND FINANCIAL
INSTRUMENTS
INTERMEDIATE ACCOUNTING 3
PREPARED BY: Mabahin, Mharian Joy F.

DISCLAIMER: This paper is prepared by bonafide NUJPIANS for A.Y. 2021-2022.

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EXCLUSIVE FOR ACCOUNTANCY STUDENTS OF NATIONAL UNIVERSITY ONLY

COMPOUND FINANCIAL INSTRUMENT

- “a financial instrument that contains both liability and equity from the
perspective of the issuer”
- Accounting for compound instrument: the issuer should determine first if
the instrument contains both financial liability and equity component. If so,
split accounting shall apply wherein the two financial instrument is
accounted for separately. The fair value of the liability component is
determined first then the residual amount is applied to the equity
component.
Common examples:
1. Bonds Payable issued with share warrants
2. Convertible Bonds Payable

BONDS PAYABLE ISSUED WITH SHARE WARRANTS

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- the bondholders were given the right to acquire the shares of the issuing
entity at specifiedprice at a future time
- Could either be detachable (traded separately from the bonds) or non-
detachable (not traded separately from the bonds), either way the warrants
have a value and accounted forseparately
- Once exercised, bonds payable will still remain and it should be paid first
- Allocation of issue price:

ISSUE PRICE
If the market value of the bond ex-
warrant is unknown, the amount to be
used is the present value of principal and
present value of interest payments of the
Allocate first to the Allocate the similar bonds without warrants
fair value of bonds residualamount to
payable ex- the sharewarrants
warrants.

SAMPLE PROBLEM:
Rasl Company issued 4-year bonds with share warrants that have a face
amount of 3,000,000 for 3,300,000. The bondholders can purchase 50,000 equity
shares with a P10 par for P15. At the timeof issuance, the bond ex-warrant has a fair
value of 3,150,000. 50% of the share warrants were exercised.
Computation: Journal Entries:

Upon issuance:
ISSUE PRICE: Cash 3,300,000
Bonds Payable 3,000,000
3,300,000 Premium on Bonds Payable 150,000
Share Warrants Outstanding 150,00
Upon exercise of share
Bonds payable Share warrants: warrants:
ex-warrants: (3,300,000 - 3,150,000) Cash (50,000 x 50% x 15) 375,000
Share Warrants 75,000
3,150,000 150,000 Outstanding (150,000 x
50%)
Share Capital (50,000 x 250,000
10)
UponShare
expiration of the remaining share warrants:
Premium - Issuance 200,000
Share Warrants
Outstanding (150,000 – 75,000
75,000)
Share Premium 75,000
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JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

CONVERTIBLE BONDS
– The bondholders were given the right to convert their bonds into share
capital or othersecurities of the issuing entity within specified time
– Two accounting scenarios that may arise with regard convertible bonds are:
1. When the bonds were converted into shares, bonds payable
will be derecognized inreplace of the share
2. When the bonds were not converted into shares rather paid
either at maturity orbefore its maturity

– Allocation of issue price:

ISSUE PRICE
If the market value of the bond ex-
conversion privilege is unknown, the
amount to be used is the present value of
Allocate first to the principal and present value of interest
Allocate the residual payments of the similar bonds without
fair value of bonds
amount to the
f payable ex- conversion privilege Page 2 o
conversion privilege
conversion privilege

SAMPLE PROBLEM:
Scenario 1 bonds were converted -
Breakdown Enterprise issued 4-year bonds with conversion privilege that has
a face amount of 7,000,000 for 7,500,000. The bondholders can covert the
bonds into 500,000 equity shares with a P5 par for P8. At the time of
issuance, the bond ex-conversion privilege has a fair value of 6,800,000. All
of the bonds payable were converted but there is still 50,000 unamortized
discounts on the same date. Also, there is still an accrued interest on bonds
payable amounting to 40,000 which was not yet paid.
Computation: Journal Entries:
Upon Issuance:
ISSUE PRICE: Cash 7,500,000
Discount on Bonds 200,000
7,500,000 Payable
Bonds Payable 7,000,000
Share Premium- Conversion 700,000
Bonds payable Conversion Privilege
ex- conversion privilege: Upon conversion of
privilege: (7,500,000 - bonds:
6,800,000) Bonds Payable 7,000,000
6,800,000
Share Premium-
700,000 700,000
Conversion
Privilege
Interest Expense 40,000
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JUNIOR PHILIPPINE INSTITUTE OF ACCOUNTANTS

Discount on Bonds 50,000

Payable
Share Capital (500,000 2,500,000
x 5)
Share Premium- Issuance 5,150,000
(7,000,000 – 50,000 +
700,000 – 2,500,000)
Cash 40,000

Scenario 2 bonds were not converted but paid before maturity –

Breakdown Enterprise issued 4-year bonds with conversion privilege that has a face
amount of 7,000,000 for 7,500,000 which will mature at December 31, 2022. The
bondholders can covert the bonds into 500,000 equity shares with a P5 par for P8.
At the time of issuance, the bond ex- conversion privilege has a fair value of
6,800,000.
On December 31, 2020 the bonds payable were still not converted and the
enterprise decided to already pay the bonds. At the time of payment, a discount
amounting to 50,000 is still unamortized and a 40,000 accrued interest was still
unpaid. The fair value of the bonds with conversion privilege is 6,500,000 while the
fair value of the bonds without conversion Privilege is 6,200,000.
Computation:

Upon Issuance of Bonds Upon Payment of Bonds

ISSUE PRICE: FAIR VALUE:

7,500,000 6,500,000

Bonds payable Conversion

ex- conversion privilege:
privilege: (7,500,000 -
6,800,000) FV of bonds FV of conversion
6,800,000 payable ex- privilege:
700,000 conversion (7,500,000 -
privilege: 6,800,000)
6,200,000 300,000

Bonds Payable 7,000,000

Discount on Bonds Payable (50,000)
Carrying Amount of Bonds Payable 6,950,000
FV of bonds payable ex-conversion privilege: (6,200,000)
Gain on Extinguishment 750,000
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Journal Entries:

Upon issuance:
Cash 7,500,000
Discount on Bonds Payable 200,000
Bonds Payable 7,000,0
00 Upon payment of bonds before maturity:
Share Premium- Conversion 700,00 Bonds Payable 7,000,000
Privilege 0 Share Premium- 300,000
Conversion Privilege @
Upon closing of the remaining conversion FV
privilege: Interest Expense 40,000
Share Premium- 400,000 Discount on Bonds 50,000
Conversion Privilege Payable
(700,000 – 300,000) Cash (6,500,000 + 6,540,000
Share Premium- 400,00 40,000)
Issuance 0 Gain on Extinguishment 750,000

Scenario 3 bonds were not converted and paid at maturity -

Breakdown Enterprise issued 4-year bonds with conversion privilege that has a face
amount of 7,000,000 for 7,500,000 which will mature at December 31, 2020. The
bondholders can covert the bonds into 500,000 equity shares with a P5 par for P8.
At the time of issuance, the bond ex- conversion privilege has a fair value of
6,800,000. December 31, 2020 has come yet all of the bonds payable were not
converted and a 40,000 accrued interest was not yet paid.

Computation: Journal Entries:

ISSUE PRICE: Upon issuance:

Cash 7,500,000
7,500,000 Discount on Bonds Payable 200,000
Bonds Payable 7,000,000
Share Premium- Conversion 700,000
Privilege
Upon payment of bonds payable at maturity:
Bonds Payable 7,000,000
Interest Expense 40,00
Bonds payable Conversion 0
Cash 7,040,000
ex- conversion privilege:
privilege: (7,500,000 - Upon expiration of the conversion privilege:
6,800,000) Share Premium- Conversion 700,000
6,800,000 Privilege
700,000 Share Premium - Issuance 700,00
0

SOURCES:
Peralta, J., Valix, C. A., &Valix, C. (2019). Intermediate Accounting Vol. 2.