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Financial Accounting 2 > Chapter 7 - Compound Financial Instrument > Flashcards

Chapter 7 - Compound Financial Instrument Flashcards

1
Q

The term “financial instrument” encompasses a _____, a _____, and an _____.

A

Financial asset
Financial liability
Equity instrument

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2
Q

The characteristics of financial instruments are (3)

A

A. There must be a CONTRACT

B. there are at least TWO PARTIES to the contract

C. The contract shall give rise to a financial asset of one party and financial liability or equity instrument of another party

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3
Q

Examples of financial instrument (7)

A
  1. Cash in the form of notes and coins
  2. Cash in the form of checks
  3. Cash in bank
  4. Trade accounts
  5. Notes and loans
  6. Debt securities
  7. Equity securities

Note that most financial instruments involve one party having a contractual right to receive cash or another financial asset and another party having a contractual obligation to deliver cash or another financial asset

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4
Q

A financial liability is any liability that is a contractual obligation (2)

A

A. To deliver cash or other financial asset to another entity

B. To exchange financial instruments with another entity under conditions that are potentially unfavorable

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5
Q

This is a financial asset of the holder or bearer and a financial liability of the issuing government

A

Cash in the form of notes and coins

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6
Q

Financial asset of the payee and financial liability of the drawer or issuer

A

Cash in the form of checks

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7
Q

Financial asset of the depositor and a financial liability of the depository bank

A

Cash in bank

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8
Q

Financial asset if the seller as accounts receivable and financial liability of the customer or buyer as accounts payable

A

Trade accounts

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9
Q

Financial asset of the lender or creditor as notes receivable or loans receivable and a financial liability of the borrower or debtor as notes payable or loans payable

A

Notes and Loans

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10
Q

Financial asset of the investor and a financial liability of the issuer

A

Debt securities

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11
Q

Financial asset of the investor and an equity of the issuer

A

Equity securities

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12
Q

Example of financial liabilities

Financial liabilities representing a contractual obligation to deliver cash in the future include (4)

A

A. Trade accounts payable
B. Notes payable
C. Loans payable
D. Bonds payable

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13
Q

Items such as _____ and _____ are NOT FINANCIAL LIABILITIES because the outflow of economic benefits associated with them is the delivery of goods and services rather than a contractual obligation to pay cash or another financial asset

A

Deferred revenue

Warranty obligations

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14
Q

Liabilities, such as _____, that are created as a result of STATUTORY REQUIREMENTS imposed by the government are NOT also financial liabilities.

A

Income taxes payable

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15
Q

_____ are NOT financial liabilities because the obligations do not arise from contracts

A

Constructive obligations

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16
Q

A contractual obligation to exchange under potentially _____ condition is an option written or issued by the issuer to sell shares in a specified entity at LESS THAN market price. This contractual obligation is a financial liability.

A

Unfavorable

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17
Q

Any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

A

Equity instrument

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18
Q

Include ordinary share capital, preference share capital, and warrants or option

A

Equity instruments

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19
Q

PAS 32, paragraph 28, defines a _____ as a “financial instrument that contains both a liability and an equity element from the perspective of the issuer”

A

Compound financial instrument

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20
Q

One component of the financial instrument meets the definition of a financial liability and another component of the financial instrument meets the definition of an equity instrument.

A

Compound financial instrument

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21
Q

The common examples of compound financial instrument are as follows (2)

A

A. Bonds payable issued with share warrants

B. Convertible bonds payable

22
Q

If the financial instrument contains both a liability and an equity component, PAS 32 mandates that such components _____.

A

Shall be accounted for separately

23
Q

The approach in accounting for a compound financial instrument is to apply _____.

A

Split accounting

24
Q

This means that the consideration received from the issuance of the compound financial instrument shall be allocated between the liability and equity components

A

Split accounting

In other words, the fair value of the liability component is FIRST DETERMINED.

The fair value of the liability component is then deducted from the total consideration received from the issuance of the compound financial instrument. The RESIDUAL AMOUNT is allocated to the equity component.

25
Q

These are granted to enable the holders to acquire equity shares at a specified price during a definite period.

A

Share warrants

26
Q

Sometimes, in order to promote the sale of the binds, the terms of the bind issue provide that _____ will be part of the bond package.

A

Share warrants

27
Q

When the bonds are sold with share warrants, the bondholders are given the right to acquire shares of the issuing entity at a specified price at some future time.

Actually, in this case, two securities are sold - the _____ and the _____.

A

Binds

Share warrants

28
Q

Share warrants attached to a bond may be _____ or _____.

A

Detachable

Nondetachable

29
Q

Can be traded separately from the bond.

A

Detachable warrants

30
Q

Cannot be traded separately from the bond

A

Nondetachable warrants

31
Q

Bonds issued with share warrants are considered as _____.

A

Compound financial instrument

Accordingly, the issuer of the BONDS PAYABLE shall classify the liability and equity components separately

32
Q

PAS 32 _____ whether the equity component is detachable or nondetachable

A

Does not differentiate

33
Q

Whether detachable or nondetachable, _____ and therefore shall be accounted for separately.

A

The warrants have a value

34
Q

The bonds are assigned an amount equal to the _____, regardless of the market value of the warrants.

A

Market value of the bonds ex-warrants

35
Q

The _____ or remainder of the issue price shall then be allocated to the warrants

A

Residual amount

This approach is based on the definition of an equity instrument as “a contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities”

36
Q

An entity frequently makes its bond issue more attractive to investors by making the bonds _____.

A

Convertible

37
Q

Those which gives the holders the right to convert their bondholdings into share capital or other securities of the issuing entity within a specified period of time.

A

Convertible bonds

38
Q

Convertible bonds are conceived as _____

A

Compound financial instruments

39
Q

The issuance of convertible bonds shall be accounted for as _____ and _____.

A

Partly liability

Partly equity

40
Q

The issue price of the convertible binds shall be allocated between the _____ and the _____.

A

Bonds payable

Conversion privilege

41
Q

R: The economic effect of issuing convertible bonds is substantially the same as issuing simultaneously bonds payable with share warrants.

A

Okay

42
Q

The binds are assigned an amount equal to the _____.

A

Market value of the bonds without the conversion privilege

The RESIDUAL AMOUNT or remainder of the issue price shall then be allocated to the conversion privilege or equity component.

43
Q

In the absence of market value of the bonds without conversion privilege, the amount allocated to the bonds is equal to the _____ using the effective or market interest rate for similar bonds without conversion privilege

A

Present value of the principal bond liability plus the present value of future interest payments

44
Q

If bonds are converted into share capital of the issuing entity, the accounting problem is the _____ to be assigned to the share capital issued.

A

Determination of a value

45
Q

The ____ of the binds is the measure of the share capital issued because it is the “effective price” for the shares issued as a result of the conversion

A

Carrying amount

46
Q

Application Guidance 32 of PAS 32 provides that _____.

A

There is no gain or loss on conversion at maturity.

The convertible bond is viewed in substance as an equity and the conversion is really an exchange of one type of equity capital for another.

47
Q

Any cost incurred in connection with the bond conversion shall be deducted from share premium or debited to _____

A

“Share issue cost”

48
Q

The _____ is equal to the face value plus accrued interest IF NOT PAID, plus unamortized premium or minus unamortized discount and bind issue cost.

A

Carrying amount of the bonds

49
Q

Accounting procedures

A

A. The amortization of discount and issue cost or premium up to the date of conversion shall be recorded.

B. The face of the bonds converted shall be cancelled together with the related unamortized premium or discount and issue cost.

C. Normally, conversion is at an interest date. When at other dates, the accrued interest up to the date of conversion is ordinarily paid.

If the interest is not paid, it is added to the face value of the bonds converted to get the carrying amount of the bonds for conversion purposes. The accrued interest is charged to interest expense.

50
Q

PAS 32 paragraph 11, defines a _____ as any contract that gives rise to both a FINANCIAL ASSET of one entity and a FINANCIAL LIABILITY or EQUITY INSTRUMENT of another entity.

A

Financial instrument

Financial Accounting 2 (5 decks)

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