Financial Accounting and Reporting PAS 32 requires that the component parts be accounted for and presented separately

according to their substance based on the definitions of liability and equity.

P1.020_Bonds Payable SMC 😊
When to split?

Lecture Notes The split is made at issuance and not revised for subsequent changes in market interest rates,
share prices, or other event that changes the likelihood that the conversion option will be
Nature of bonds payable exercised.

A Bond is a formal unconditional promise, made under seal, to pay a specified sum of money at
a determinable future date, to make periodic interest payment at a stated rate until the principal
sum is paid.
Bonds payable are financial liabilities since they represent contractual obligation to pay cash or
other financial assets.
How to split?
When the initial carrying amount of a compound financial instrument is required to be allocated
to its equity and liability components, the equity component is assigned the residual amount after
deducting from the fair value of the instrument as a whole the amount separately determined for
the liability component. This is also known as “with-and-without method”.

Derecognition of a Financial Liability Retirement of Convertible Bonds Before Maturity

• A financial liability should be removed from the statement of financial position when, and • When an entity extinguishes a convertible instrument before maturity, the entity allocates the
only when, it is extinguished, that is, when the obligation specified in the contract is either consideration paid and any transaction costs for the repurchase or redemption to the liability
discharged, cancelled, or expired. and equity components of the instrument at the date of the transaction

• Where there has been an exchange between an existing borrower and lender of debt • The method used in allocating the consideration paid and transaction costs to the separate
instruments with substantially different terms, or there has been a substantial modification of components is consistent with that used in the original allocation to the separate
the terms of an existing financial liability, this transaction is accounted for as an components of the proceeds received by the entity when the convertible instrument was
extinguishment of the original financial liability and the recognition of a new financial liability. issued

• A gain or loss from extinguishment of the original financial liability is recognized in the income • Once the allocation of the consideration is made, any resulting gain or loss is treated in
statement. accordance with accounting principles applicable to the related component, as follows:
(a) the amount of gain or loss relating to the liability component is recognized in profit or loss;
Compound Financial Instruments and
(b) the amount of consideration relating to the equity component is recognized in equity.
Definition

Financial instruments that have both a liability and an equity component from the issuer's
Illustrative Cases
perspective.
1. Pulilio Company’s December 31, 2017 statement of financial position contained the following
Examples:
items in the long-term liabilities section:
To illustrate, a convertible bond contains two components. One is a financial liability, namely the
10% registered bonds, callable in 2018,
issuer's contractual obligation to pay cash, and the other is an equity instrument, namely the
due 2020, secured by machinery
holder's option to convert into common shares. Another example is debt issued with detachable
P3,000,000
share purchase warrants.
11% bonds, convertible into ordinary
shares beginning in 2018, due in 2017,
Split accounting
secured by realty 5,000,000
12% collateral trust bonds (P500,000
maturing annually) 7,000,000

What is the total amount of Pulilio’s term bonds and debenture bonds, respectively?
2. On March 1, 2017, Tiaong Company issued 10,000 of its P1,000 face value bonds at 95 plus
accrued interest. Tiaong Company paid bond issue cost of P1,000,000. The bonds were
dated November 1, 2016, mature on November 1, 2021, and bear interest at 12% payable
semiannually on November 1 and May 1. The net amount that Tiaong receive from the bond
issuance is
On January 3, 2017, all of the bonds were converted into ordinary shares. The market price of the
shares was P28 per share on the date of conversion. The issue premium is amortized using the
straight-line method.
5. The issuance of the bonds increased the entity’s equity by
6. The conversion of the bonds increased the entity’s equity by

Use the following information for the next two questions.

3. On January 1, 2017, Marimar Company issued 10,000 of its 12%, P1,000 face value 5-year
bonds at 105. Interest on the bonds is payable annually every December 31. In connection On 1 January 2007, Entity A issued a 10 per cent convertible debenture with a face value of
with the sale of these bonds, Marimar paid the following expenses: P10,000,000 maturing on 31 December 2016. The debenture is convertible into ordinary shares of
Entity A at a conversion price of P25 per share. Interest is payable half-yearly in cash. At the
Promotion costs P100,000 date of issue, Entity A could have issued nonconvertible debt with a ten-year term bearing a
Engraving and printing 400,000 coupon interest rate of 11 per cent.
Underwriter’s commissions 500,000
On 1 January 2017, the convertible debenture has a fair value of P11,200,000. Entity A makes a
Using the straight line method, what amount should Marimar report as bond interest expense tender offer to the holder of the debenture to repurchase the debenture for P11,200,000, which
for the year 2017? the holder accepts. At the date of repurchase, Entity A could have issued non-convertible debt
with a five-year term bearing a coupon interest rate of 8 per cent.
4. On March 1, 2017, Pyne Furniture Co. issued P700,000 of 10 percent bonds to yield 8 percent.
Interest is payable semiannually on February 28 and August 31. The bonds mature in ten 7. Compute the amount to be recognized in profit or loss as a result of the repurchase of the
years. Pyne Furniture Co. is a calendar-year corporation. debenture.

Compute the interest expense to be reported in 2017. 8. Compute the amount to be recognized in equity as a result of the repurchase of the
debenture.

SOLUTION GUIDE:

NI (5%) EI (4%) Prem.

Date Amort. A.C.

3/1/12 795,141

8/31/12 35,000 31,806 3,194 791,947

2/28/13 35,000 31,678 3,322 788,625

Use the following information for the next two questions.

On January 2, 2007, Picard Enterprises issued P2,400,000 of 8 percent, 15-year semiannual coupon
bonds. Each bond is convertible into 40, P15 par, ordinary shares, which was trading at P20 per
share on the date of the bond issue. The bonds were issued at 106. Without the conversion
feature, the bonds would have been issued for 104.5.