Compound financial instrument (IAS 32, IFRS 9)

Question 1

what is a compound instrument?

Answer 1

A financial instrument that contains characteristics of both financial liabilities and equity instruments simultaneously. e.g. convertible debt

Question 2

these components needs to be classified separately to reflect economic substance of the financial instrument, how to do this ‘split accounting’ for the issuer?

Answer 2

1. Meausre the FV of the instrument on recognition (usually the consideration received on the issue).
2. Determine the amount of the financial liability component using the PV of a similar liability without conversion to the equity component.
3. The residual amount (1-2) is assigned to the equity element of the instrument

Question 3

Legally, compound financial instrument would be defined as a liability of the issue, but, in the accounting we show the economic substance being…

Answer 3

Obligation. to pay interest to he bond holder

potential obligation to pay cash on redemption to the bond holder

A potential right to supply equity instruments (shares of the issuer) is given to the bond holder = share warrant

Question 4

Why does split accounting give more relevant and comparable information?

Answer 4

Because the liability component is initialy measured at FV (using pv techqniues) subsequently, measured at amortised cost in line with similar non-convertible liabilities.

Question 5

However, treatment of equity component as a ‘residual’ has been criticised, why?

Answer 5

Equity is not recorded at FV nor it is remeasured.

This could be shown to be a weaker argument as an entity’s own issued shares are not remeasured after issue and IFRS 2 similarly does not revalue equity-based share-based payment after the grant date.