CH 9 COMPOUND FINANCIAL INSTRUMENT PRACTICE PROBLEM PDF

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Chapter 9 COMPOUND FINANCIAL INSTRUMENT Problem 9-1 (AICPA Adapted) At year-end, Fort Company issued 5,000 of 8%, 10-year, P1,000 face value bonds 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 ...

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Chapter 9 COMPOUND FINANCIAL INSTRUMENT Problem 9-1 (AICPA Adapted) At year-end, Fort Company issued 5,000 of 8%, 10-year, P1,000 face value bonds 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. b. c. d.

5,000,000 4,950,000 4,900,000 5,400,000

Solution 9-1 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 a compound financial instrument. Share warrants attached to a bond may be detachable and nondetachable. Detachable warrants can be traded separately from the bond and nondetachable warrants cannot be traded separately. PAS 32, paragraph 28, mandates that the issuer of a compound financial instrument shall classify the liability and equity component separately. This standard does not differentiate whether the equity component is detachable or nondetachable. Whether detachable or non detachable, 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 asset of the entity after deducting all of its liabilities. Accordingly, the bonds are assigned an amount equal to “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

Actually, the entry to record the issue of the bonds payable with share warrants is as follows: Cash

5,500,000

Bonds payable

5,000,000

Premium on Bonds payable

400,000

Share warrants outstanding

100,000

If all the share warrants are exercised by the bond holders, the journal entry is: Cash ( 5,000 x 10 x P25) Share warrants outstanding Share capital ( 50 x 10 x P20) Share premium

1,250,000 100,000 1,000,000 350,000

Problem 9-2 (AICPA Adapted) On December 31, 2015, Moses Company issued P5,000,000 face value, 5-year bonds at 109. Each P1,000 bond was issued with 50 detachable share warrants, each of which entitled the bond holder to purchase one ordinary share of P5 par value at P25. Immediately after issuance, the market value of each warrant was P5. The stated interest rate of 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 t 12% for 5 periods is 0.57 and the present value of an ordinary annuity of 1 at 12% for 5 periods is 3.60. On December 31, 2015, what amount should be recorded as discount or premium on bonds payable? a. b. c. d.

170,000 discount 450,000 premium 450,000 discount 800,000 discount

Solution 9-2 Answer a PV of principal ( 5,000,000 X .57)

2,850,000

PV of annual interest payment ( 550,000 x 3.60)

1,980,000

Total present value of bonds payable

4,830,000

Bonds payable

5,000,000

Present value

4,830,000

Discount on bonds payable

170,000

If the market 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 payment using the market rate of interest for similar bonds without the warrants. Issue price of bonds with warrants ( 5,000,000 x 109%) Present value of bonds payable

5,450,000 4,830,000

Residual amount allocated to warrants

620,000

Journal entry to record the issue bonds with share warrants Cash

5,450,000

Discount on bonds payable

170,000

Bonds payable

5,000,000

Share warrants outstanding

620,000

Journal entry to record the exercise of all the share warrants Cash ( 5,000 x 50 x P25) Share warrants outstanding

6,250,000 620,000

Share capital (250,000 x P5)

1,250,000

Share premium

5,620,000

Problem 9-3 (AICPA Adapted) On January 1, 2015, Case Company issued P5,000,000 of 12% nonconvertible bonds at 103 which are due on February 28, 2020. In addition, each P1,000 bond was issued with 30 detachable share warrants,

each of which entitled the bond holder to purchase, for P50, one ordinary share of Case Company, par value P25. On January 1, 2015, the quoted market value of each warrant was P4. The market value of the bond exwarrants at the time of issuance is 95. What amount of the proceeds from the bond issue should be recognized as an increase in shareholders’ equity? a. b. c. d.

600,000 300,000 200,000 400,000

Solution 9-3 Answer d Issue price of bonds with warrants ( 5,000,000 x 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

Problem 9-4 (IAA) Moriones Company issued P5,000,000 face value 12% convertible bonds at 110 on January 1, 2015, maturing on January 1, 2020 and paying interest semiannualy on January 1 and July 1. It is estimated that would sell only at 103 without the conversion feature. Each P1,000 bond is convertible into 10 ordinary shares with P100 par value. What is the increase in the shareholders’ equity arising from the issuance of the convertible bonds on January 1, 2015? a. b. c. d.

350,000 500,000 150,000 0

Solution 9-4 Answer a The issue of convertible bonds payable is also accounted for as a 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 the bonds without conversion privilege ( 5,000,000 x 103)

5,150,000

Residual amount allocated to conversion privilege

350,000

Actually, the journal entry to record the issuance of the convertible bonds payable i s: Cash

5,500,000 Bonds payable

5,000,000

Premium bonds payable

150,000

Share premium-conversion privilege

350,000

Problem 9-5 (IAA) Susan Company issued 5,000 convertible bonds on January 1, 2015. The bonds have a three-year term and are issued at 110 with a face value 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 P5. 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 is the equity component of the issuance of the convertible bonds on January 1, 2015? a. b. c. d.

1,150,000 1,650,000 891,000 391,000

Solution 9-5 Answer c PV of principal ( 5,000,000 x .77) PV of annual interest payments ( 300,000 x 2.53) Total present value of bonds

3,850,000 759,000 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 principal bond liability plus the present value of the future interest payments using the market rate of interest for similar bonds without the conversion privilege.

Problem 9-6 (AICPA Adapted) Spare Company had outstanding share capital with par value of P50,000,000 and a 12% convertible bond payable in the face amount of P10,000,000. Interest payment dates of bond issue are June 30 and December 31. The conversion clause in the bond indenture entitled the bond holders to receive 40 shares of P20 par value in exchange for each P1,000 bond. On June 30, 2015, the holders of P5,000 face value bonds 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 that date of conversion was P500,000. The share premium from conversion privilege has a balance of P2,000,000 on June 30, 2015. What amount of share premium should be recognized by reason of the conversion of bonds payable into share capital? a. b. c. d.

2,000,000 2,750,000 3,000,000 1,750,000

Solution 9-6 Answer d Bonds payable

10,000,000

Discount on bonds payable

(

Carrying amount

500,000) 9,500,000

Carrying amount converted (5/10 x 9,500,000)

4,750,000

Applicable share premium from conversion privilege ( 5/10 x 2,000,000)

1,000,000

Total consideration

5,750,000

Par value of shares issued ( 5,000 x 40= 200,000 shares x 20)

4,000,000

Share premium from conversion

1,750,000

Problem 9-7 (IFRS) On December 31, 2015, Green Company issued 2,000 convertible bonds with a nominal interest rate of 7% at P2,000 each. Each bond can be converted into 5 new equity shares or redeemed for cash, at the option of the holder, in 5 years’ time. The fair value of the date of similar bonds without the convertibility option was estimated at P1,500 each. What is the amount recognized in equity in respect of the issuance of convertible bonds on December 31, 2015? a. b. c. d.

4,000,000 3,000,000 1,000,000 0

Solution 9-7 Answer c Issue price (2,000 x P2,000)

4,000,000

Fair value of bonds without option ( 2,000 x P1,500)

3,000,000

Equity component

1,000,000

Problem 9-8 (AICPA Adapted) Clay Company had P600,000 convertible 8% bonds payable outstanding on June 30, 2015. Each P1,000 bond was convertible into 10 ordinary shares of P50 par value. On July 1, 2015, 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. What is the increase in the share capital and share premium respectively, as a result of the bond conversion? a. b. c. d.

300,000 and 312,000 306,000 and 306,000 450,000 and 162,000 600,000 and 12,000

Solution 9-8 Answer a Bonds payable Premium on bonds payable

600,000 12,000

Carrying amount

612,000

Ordinary share issued at par value ( 6,000 x 50)

300,000

Share premium

312,000

Problem 9-9 (AICPA Adapted) On December 31, 2015, Cey Company had outstanding 10%. P1,000,000 face amount convertible bond payable maturing on December 31, 2018. Interest is payable on June 30 and December 31. Each P1,000 bond is convertible into 50 shares of P10 par value. On December 31, 2015, the unamortized premium on bonds payable was P60,000. On December 31, 2015, 400 bonds were converted when Cey’s share had a 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 is the share premium from the issuance of shares as a result of the bond conversion on December 31, 2015? a. b. c. d.

176,000 220,000 276,000 280,000

Solution 9-9 Answer b Bonds payable

1,000,000

Premium on bonds payable Carrying amount

60,000 1,060,000

Carrying amount converted ( 400/1,000 x 1,060,000)

424,000

Par value of shares issued ( 400 x 50 x P10)

200,000

Share premium

224,000

Conversion expenses Net share premium

(

4,000) 220,000

Problem 9-10 (IAA) 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 value 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 bonds is 9%. At the issuance date, the amount of P485,000 was credited to share premium for conversion privilege. The bonds were not converted and instead, the entity paid of the convertible bondholders as maturity. What amount should be recorded as gain or loss on the full payment of the convertible bonds at maturity? a. 2,500,000 gain b. 485,000 loss c. 485,00 gain d. 0

Solution 9-10 Answer d To record the issuance of convertible bonds: Cash Discount on bonds payable

5,000,000 485,000

Bonds payable

5,000,000

Share premium-conversion privilege

485,000

To record the settlement of the convertible bonds at maturity date: Bonds payable Interest expense ( 6% x 5,000,000)

5,000,000 300,000

Cash

Share premium-conversion privilege Share premium-issuance

5,300,000

485,000 485,000

Problem 9-11 (IAA) On January 1, 2015, Arlene Company issued convertible bonds with a face value of P5,000,000 for P6,000,000. The bonds are convertible into 50,000 shares with P100 par value. The bonds have a 5year life with 10% stated interest payable annually every December 31. The fair value of the convertible bonds without conversion option is computed at P5,399,300 on January 1, 2015. On December 31, 2017, the convertible bonds were not converted but fully paid for P5,500,000. On such date, the fair value of the bonds without conversion privilege is P5,400,000 and the carrying amount is P5,178,300. What is the loss of the extinguishment of the convertible bonds on December 31, 2017? a. 221,700 b. 371,700 c. 150,000 d. 0

Solution 9-11 Answer a Issue price

6,000,000

Fair value of the bonds without conversion option

5,399,300

Share premium-conversion privilege

600,700

Total payment – December 31, 2017

5,550,000

Payment applicable to bonds payable

(5,400,000)

Equity component

150,000

Carrying amount on bonds payable

5,178,300

Payment applicable to bonds payable

(5,400.000)

Loss on extinguishment

( 271,000)

Journal entries on December 31,2017 Bonds payable

5,000,000

Premium on bonds payable

178,300

Share premium-conversion privilege

150,000

Loss on extinguishment

221,700

Cash

Interest expense ( 10% x 5,000,000)

550,000

500,000

Cash Share premium-conversion privilege Share premium-issuance ( 600,700 – 150,000)

500,000 450,700 450,700

Problem 9-12 (AICPA Adapted) At year-end, Guadalupe Company issued 6,000 of 9%, 10-year, P1,000 face value bonds 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 P6,400,000 and the market value of the warrants was P500,000. What is the carrying amount of bonds payable at year-end? a. b. c. d.

5,000,000 5,950,000 4,600,000 6,400,000

Solution 9-12 Answer d Issue price of bonds payable – equal to market value without the warrants

6,400,000

Problem 9-13 (IAA) Gutierrez Company issued P5,000,000 face value 12% convertible bonds at 120 on January 1, 2015, maturing on January 1, 2020 and paying interest semiannualy on January 1 and July 1. It is estimated that would sell only at 103 without the conversion feature. Each P1,000 bond is convertible into 10 ordinary shares with P100 par value. What is the increase in the shareholders’ equity arising from the issuance of the convertible bonds on January 1, 2015? a. b. c. d.

850,000 500,000 150,000 0

Solution 9-13 Answer a The issue of convertible bonds payable is also accounted for as a 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 120)

6,000,000

Market value of the bonds without conversion privilege ( 5,000,000 x 103)

5,150,000

Residual amount allocated to conversion privilege

850,000

Actually, the journal entry to record the issuance of the convertible bonds payable is: Cash

6,000,000 Bonds payable

5,000,000

Premium bonds payable

150,000

Share premium-conversion privilege

850,000

Problem 9-14 (AICPA Adapted) On January 1, 2015, Case Company issued P5,000,000 of 12% nonconvertible bonds at 106 which are due on February 28, 2020. In addition, each P1,000 bond was issued with 30 detachable share warrants, each of which entitled the bond holder to purchase, for P50, one ordinary share of Case Company, par value P25. On January 1, 2015, the quoted market value of each warrant was P4. The market value of the bond exwarrants at the time of issuance is 97. What amount of the proceeds from the bond issue should be recognized as an increase in shareholders’ equity? a. b. c. d.

600,000 300,000 400,000 450,000

Solution 9-14 Answer d Issue price of bonds with warrants ( 5,000,000 x 106%)

5,300,000

Market value of bonds without warrants (5,000,000 x 95%)

4,850,000

Residual amount allocated to warrants-equity component

450,000

Problem 9-15 (IFRS) On December 31, 2015, Green Company issued 3,000 convertible bonds with a nominal interest rate of 7% at P3,000 each. Each bond can be converted into 5 new equity shares or redeemed for cash, at the option of the holder, in 5 years’ time. The fair value of the date of similar bonds with...