ExpertMedium2 marksMultiple Choice
ACCA · Question 07 · IFRS 9 Financial Instruments
Section A
SolarMax, a renewable energy firm, issued $5 million of 4% convertible bonds at par on 1 January 20X5. Interest is payable annually in arrears. The bonds are redeemable at par on 31 December 20X7 or convertible into equity shares. The prevailing market interest rate for similar bonds without the conversion option is 8%.
Discount factors at 8%: Year 1: 0.926, Year 2: 0.857, Year 3: 0.794.
What amount will be credited to equity upon the initial recognition of this compound financial instrument on 1 January 20X5?
Section A
SolarMax, a renewable energy firm, issued $5 million of 4% convertible bonds at par on 1 January 20X5. Interest is payable annually in arrears. The bonds are redeemable at par on 31 December 20X7 or convertible into equity shares. The prevailing market interest rate for similar bonds without the conversion option is 8%.
Discount factors at 8%: Year 1: 0.926, Year 2: 0.857, Year 3: 0.794.
What amount will be credited to equity upon the initial recognition of this compound financial instrument on 1 January 20X5?
Answer options:
A.
$200,000
B.
$515,400
C.
$514,600
D.
$4,485,400
How to approach this question
Use split accounting. 1. Calculate the present value of the future cash flows (interest and principal) using the market rate without the conversion option (8%). This is the liability component. 2. Deduct the liability component from the total proceeds to find the equity component.
Full Answer
C.$514,600✓ Correct
Under IFRS 9, convertible bonds are compound financial instruments. They must be split into liability and equity components.
Cash flows:
Year 1: Interest $200,000 x 0.926 = $185,200
Year 2: Interest $200,000 x 0.857 = $171,400
Year 3: Interest + Principal $5,200,000 x 0.794 = $4,128,800
Total Liability Component = $4,485,400.
Total Proceeds = $5,000,000.
Equity Component (residual) = $5,000,000 - $4,485,400 = $514,600.
Common mistakes
Discounting using the coupon rate (4%) instead of the market rate (8%), or selecting the liability figure instead of the equity figure.
Practice the full ACCA FR — Financial Reporting Practice Exam 5
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