Problem Set – Compound Financial Instrument

Instructions:
Please read the discussion on Compound Financial Interest (Valix, 2020) before answering the
practice sets below. Only one member will submit the answers in PDF file, with computations.
The other team members will just indicate the name of the group member who submitted the
PDF file. No need for everyone in the group to upload the PDF file. Submission will be made by
group, and the same grade will be given to all members. Deadline of submission is on 24
September, 11:59 pm. Online discussion of answers will be during our class on 25 September.
For those who are unable to join the online discussion, the video discussion will be uploaded on
26 September.

1. On 1 January 2020, ABC Corp. issued at 95, one thousand of its 8%, P5,000 bonds due
in ten years. One detachable stock purchase warrants entitling the holder to buy 20
shares of ABC’s ordinary shares was attached to each bond. Shortly after issuance, the
bonds are selling at 10% ex warrant, and each warrant was quoted at P60. The
present value factors are the following:

PV of 10% for an ordinary annuity of P1 after 10 periods 6.415

PV of 10% after 10 interest periods .385

a. What is the carrying value of the bonds at date of issuance?

b. What is the carrying value of the bonds at December 31, 2020?

c. What amount, if any, of the proceeds from the bond issuance should be recorded
as part of ABC’s shareholder’s equity?

d. What is the fair value of the bonds ex-warrant?

e. What will happen to the Share Warrants if not exercised?

2. On 1 January 2020, ABC Corp. issued its 5-year, 12% P5,000,000 face value convertible
debt instrument for P4,800,000. The debt instrument is convertible into 80,000
ordinary shares with par value of P50 per share and can be converted from January
2021 to maturity. At the time of issue, the market rate of interest for a similar
instrument is 14%. Interest is payable every six months on January 1 and July 1.

On 1 July 2021, the entire debt instrument was converted into equity instrument by the
issuance of 80,000 ordinary shares of the enterprise. Transaction costs of P50,000 were
incurred, in relation to the issue of new shares. The quoted price of the convertible
bonds at even date without the conversion privilege is 95.

PV of 7% for an ordinary annuity of P1 after 10 periods 7.024

PV of 7% after 10 interest periods .508

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Problem Set – Compound Financial Instrument

a. What is the carrying value of the bonds on 1 July 2021?

b. What amount should be credited to the share premium account as a result of the
conversion of 80,000 ordinary shares?

c. What is the journal entry if only 40,000 ordinary shares were converted on July 1,
2021?

d. What amount should be credited to the share premium account if the conversion of
80,000 ordinary shares occurred on 31 December 2021 (instead of 1 July 2021)?

e. How much is the gain/loss on extinguishment of bond, if ABC Corp. settles the
entire debt instrument on 1 July 2021 for P4,950,000?