IAS 32 Financial Instruments Presentation | IFRS Lectures | ACCA Exam | International Accounting
Summary
TLDRProfessor Farhad introduces IFRS 32, focusing on financial instruments and their presentation. He defines financial assets, liabilities, and equity, explaining their characteristics and differences. The session covers the basics of financial instruments, including contracts that give rights to receive cash or exchange financial assets and liabilities. The professor also discusses the classification of financial instruments as liabilities or equity, highlighting the importance of understanding contractual obligations. Examples of financial liabilities and equity instruments are provided, with an emphasis on the distinction between the two for proper accounting treatment.
Takeaways
- đ The session focuses on IFRS 32, which deals with the presentation of financial instruments.
- đ Professor Farhad reminds viewers to connect with him on various platforms like YouTube, Instagram, and Facebook for more accounting, auditing, and tax lectures.
- đ The topic of financial instruments is briefly covered in the CPA and ACCA exams.
- đ» The instructor's website offers donations to support the channel and promotional offers for study materials like Becker's courses with $1,000 off.
- đ Becker's course provides extensive study materials including over 10,000 multiple-choice questions and exercises for CPA exam preparation.
- đ The definition of a financial instrument according to IFRS 32 is a contract that gives rise to both a financial asset for one entity and a financial liability or equity for another.
- đŒ Financial assets include cash, contracts that give the right to receive cash or another financial asset, and equity instruments like stocks in another entity.
- đ Financial liabilities are contractual obligations to deliver cash or another financial asset, and can include bonds, loans, and other debt instruments.
- đą Equity instruments represent a residual interest in the assets of an entity after deducting liabilities, but do not include instruments accounted for under the equity method or consolidated method.
- đ The distinction between financial liabilities and equity instruments can depend on the contractual terms and whether the instrument can be settled in the entity's own equity.
- đ Compound financial instruments, such as convertible bonds, have features of both equity and liability and require split accounting to separately report the two components.
Q & A
What is the main focus of the session presented by Professor Farhad?
-The main focus of the session is IFRS 32, which deals with financial instruments and their presentation.
What does IFRS 32 define as a financial instrument?
-IFRS 32 defines a financial instrument as any contract that gives rise to both a financial asset of one entity and a financial liability or equity of another entity.
What are the different types of financial assets mentioned in the script?
-The different types of financial assets mentioned include cash, a contract that gives the right to receive cash or another financial asset (like debt instruments), a contractual right to exchange financial assets or liabilities under favorable conditions (like call and put options), and equity instruments.
What is the definition of a financial liability according to the script?
-A financial liability is a contractual obligation to deliver cash or another financial asset to another entity, or to exchange financial assets or liabilities under potentially unfavorable conditions.
What is the difference between equity method and the consolidated method in accounting for equity instruments?
-The equity method is used when there is significant influence (usually when ownership is between 20% and 50%), while the consolidated method is used when there is control (usually when ownership is more than 50%).
How does the script define an equity instrument?
-An equity instrument is defined as any contract that evidences a residual interest in the assets of an entity after deducting its liabilities.
What is the significance of the Federal Reserve Bank interest rate in the example of preferred stock?
-The Federal Reserve Bank interest rate is significant because if it rises above 5%, it triggers a contingency that allows the preferred stockholders to redeem their shares at par value, making it a financial liability for the company.
What is a compound financial instrument and how is it accounted for?
-A compound financial instrument is one that has features of both an equity and a liability. It should be split into its liability and equity components and accounted for separately using methods such as the with-and-without method or the incremental method.
What is the purpose of issuing convertible bonds from the issuer's perspective?
-The purpose of issuing convertible bonds is to allow the company to pay a lower interest rate than they would have to pay without the conversion feature, potentially attracting more investors and giving them the option to convert the bond into common stock.
How is the fair value of a convertible bond determined in the script's example?
-The fair value of a convertible bond is determined by comparing the bond's issue price to the present value of its principal and interest payments, using the market interest rate for similar bonds without the conversion feature.
What is the journal entry for issuing a convertible bond according to the script?
-The journal entry for issuing a convertible bond would debit cash for the total issue price, credit bonds payable for the fair value of the liability component, and credit the remainder to additional paid-in capital for the equity component.
Outlines
đ Introduction to IFRS 32 and Financial Instruments
Professor Farhad introduces the session focused on IFRS 32, which pertains to financial instruments and their presentation. He emphasizes the importance of this topic in international accounting courses and CPA and ACCA exams. The professor also encourages viewers to connect with him on various platforms, subscribe to his YouTube channel, and take advantage of premium offers on his website, such as Becker's $1,000 discount on their courses. He outlines the basic definition of financial instruments, distinguishing between financial assets, liabilities, and equity instruments, using examples like bonds and stocks to illustrate the concepts.
đŠ Equity Instruments and Their Accounting Treatment
The paragraph delves into the specifics of equity instruments, explaining how they represent a residual interest in an entity's assets after liabilities are deducted. It discusses the accounting for investments in equity instruments, particularly when the ownership percentage influences the accounting method used, such as the equity method for significant influence (20-50% ownership) and consolidation for controlling interests (over 50%). The professor clarifies that equity instruments discussed in this session are those with less than significant influence, typically considered as passive investments or marketable securities.
đ Understanding Financial Liabilities and Their Examples
This section provides a comprehensive explanation of financial liabilities, which are contractual obligations to deliver cash or other financial assets. Examples include payables, loans, bonds, and other debt instruments. The professor illustrates how the issuance of bonds results in a financial liability for the issuer and a financial asset for the bondholder. The paragraph also touches on the distinction between financial liabilities and equity, emphasizing the importance of contractual obligations in classification.
đ Classifying Equity vs. Liability in Financial Instruments
The professor explores the complexities of classifying financial instruments as either equity or liability, highlighting that some instruments may have features of both. He uses the example of preferred stocks that are redeemable or contingently redeemable, which under certain conditions should be classified as liabilities. The paragraph explains the importance of understanding the contractual terms and the substance of the arrangement to determine the correct classification.
đ Compound Financial Instruments: Split Accounting
The session continues with a discussion on compound financial instruments, which contain elements of both equity and liability. A convertible bond is used as a prime example, where the bond has a liability component (the obligation to pay interest and principal) and an equity component (the option to convert into common stock). The professor explains the split accounting method, which involves determining the fair value of each component and allocating the initial carrying amount accordingly.
đ Valuation and Accounting for Convertible Bonds
This paragraph focuses on the practical application of accounting for convertible bonds, including the process of valuation using the with-and-without method to separate the liability and equity components. An example is provided where the Sharma Corporation issues convertible bonds, and the professor demonstrates how to calculate the fair value of the bond without the conversion feature and the resulting journal entries under different GAAP standards.
đ Conclusion and Further Study Recommendations
In the concluding paragraph, the professor offers guidance for those who find the topic of bonds and their accounting complex, recommending further study in intermediate accounting, particularly chapters on bond computation and the time value of money. He invites questions and encourages donations to support the educational channel, wishing students well in their ACCA or CPA exam preparations.
Mindmap
Keywords
đĄIFRS 32
đĄFinancial Instrument
đĄFinancial Asset
đĄEquity Instrument
đĄFinancial Liability
đĄEquity Method
đĄConsolidation
đĄConvertible Bond
đĄCompound Financial Instrument
đĄSplit Accounting
đĄTime Value of Money
Highlights
Introduction to IFRS 32, focusing on financial instruments and their presentation.
Brief overview of how IFRS 32 is covered in CPA and ACCA exams.
Encouragement for viewers to subscribe and engage with the channel on social media.
Details on premium accounting, auditing, and tax lectures available on Gumroad.
Information on Becker's current offer of $1,000 off and its unlimited course access.
Explanation of financial instruments as contracts that give rise to financial assets and liabilities.
Definition and examples of financial assets, including cash, debt instruments, and equity instruments.
Clarification on the difference between passive investments and significant influence in equity method accounting.
Discussion on the classification of financial liabilities, including contractual obligations to deliver cash or other assets.
Examples of financial liabilities such as loans, bonds, and written put options.
Equity instruments defined as contracts evidencing a residual interest in an entity's assets after liabilities are deducted.
Exclusion of insurance contracts and employee benefit plans from the scope of IFRS 32.
Differentiation between equity and liabilities based on contractual obligations.
Accounting treatment of compound financial instruments, such as convertible bonds, which contain both equity and liability elements.
The split accounting method for compound financial instruments, including the with-and-without method.
Incremental method under US GAAP for compound financial instruments, contrasting with IFRS.
Example of Sharma Corporation's issuance of convertible bonds and the accounting for both liability and equity components.
Importance of understanding the time value of money for accounting students, especially in the context of bonds.
Transcripts
hello and welcome to the session this is
Professor Farhad in this session we're
going to be looking at IFRS 32 which is
financial instrument and specifically
presentation
thus topic is covered in international
accounting course a CPA exam very brief
very briefly in the ACCA exam as always
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pieces whatever you need to have so
today we're gonna focus on IAS 32 which
is financial instrument presentation so
what is that well I have IFAs 32 define
basically some very specific it defines
a financial instrument as any contract
that give the that gives rise to both a
financial asset of one entity and a
financial
liability or equity of another entity
that's all what it does oh we're gonna
be learning today is in a sense basic
definition of those fine what are they
what are financial assets what are they
financial what are financial liabilities
were not gonna look at recognition would
not gonna look at how we measured them
we're not gonna look at how do its
disclose them are we gonna do that
obviously yes but in a separate
recording and a separate and a separate
IFRS section but today we're only gonna
have to learn what is a financial asset
so if I say it this is a financial asset
in the in the following session you know
what a financial asset is okay what if I
said a financial liability order and
order an equity instrument so what is a
financial asset financial asset is
defined it as in any any asset that's
obviously cash cash as a financial asset
which we off we are all familiar with
cash that's easy a contract right a
contractual right not a contract right a
contractual right what is a contractual
right well you have the right to receive
financial another financial asset when
do you have the right to receive another
financial asset well guess what if you
buy a debt instrument if you buy a debt
investment what is it that investment
when you buy a bond when you buy a bond
you credit cash $100,000 and you debit
some sort of a debt investment so that
investment is basically you bought a
bond you bought a bond debt investment
let's assume $100,000 okay what happened
is you bought a bond by buying a bond
that's gonna give you the right to
receive cash what type of cash interests
and also it's gonna give you the right
to receive the principal amount same
thing if you lend money notes receivable
the feud if you lend money $100,000 you
will debit notes receivable basically
the same concept also a contractual
right that it to give you the right to
exchange a financial asset or a
financial liability under favorable
condition here we are talking about call
option input option what our call option
and put option co-option gives you the
right to buy an asset to buy a stock an
equity at a certain price and put option
gives you the right
don't worry about coal simple were gonna
call send pull option we're gonna cover
them in a separate recording and
separate chapter we're gonna talk a lot
about them but this is what the
definition of a financial asset is also
an equity instrument basically what is
an equity instrument an equity
instrument basically a stock basically
an investment of another entity so
basically you bought a stock and another
entity so let me just show you let's
assume you have $100,000 you bought an
equity investment in Amazon AM Z and
Amazon that's their stock symbol so you
debit 100,000 and you credit cash
100,000 so that's also a financial asset
and equity instrument it's a financial
asset that you purchase you purchase
okay a contract that will may or may not
be settled in the entity's own equity
instrument and it's not classified as an
equity instrument of the entity so it's
not your equity instrument you are not
Amazon you purchase you happen to have
some extra cash and you decided you know
what I'm not gonna keep that extra cash
in the bank
I'm gonna go ahead and buy an equity
instrument what is that equity
instrument stocks and Amazon stocks and
Amazon now now we have to be very
careful when we talk about equity
instrument because depending on how much
you buy of that equity instrument
determine how you account for it
for example investment and equity
instrument that are accounted took for
under the equity method or the
consolidated method would not fall under
the scope of is 32 or IFL IFRS 9 which
is we did not talk about IFRS 9 but it
doesn't fall under the scope of IRS IFRS
9
what is the equity method and what's the
consolidated method well it all depends
how many how many how much is your
investment in that particular company
let me show you on a timeline what we
are looking at this is zero and this is
100% of the company as long as you buy
less than 20
percent you are considered to have
what's called a passive interests
passive interest means really have no
say in the company you're a passive
investor therefore you would use what I
just showed you here this is an equity
instrument once you have more than
twenty up to fifty percent once you fall
it within this range once you fall
within this range so you have more than
twenty percent equity but you're still
less than fifty then you are considered
to be using the equity well they are
considered to have significant influence
let's use the term significant influence
it means you have some influence over
the company significant influence under
those circumstances you have to use a
method called B equity method you have
to use the equity method once you have
more than 50 percent once you own more
than 50 percent of a particular company
more than 50 percent then you have to
use the consolidation consolidate
consolidate the subsidiary okay so what
does that mean it means when we're
defining the financial instrument here
we are assuming you own less than 20
percent so only those investment and
equity that result in less than
significant influence over the other
entity sometimes they're labeled as
marketable securities are accounted for
in in accordance with IAS 32 and IFRS 9
which is again don't worry about IFRS 9
okay
so we're dealing with stocks you own the
stocks but it's less than 20 percent
what are we talking about this now
you're gonna see in the next session
when we try to recognize them and
measure them we have to know what type
of assets are we dealing with okay
that's very important so those what
those are that's what a financial asset
is let's talk about a financial
liability well a financial liability is
a contractual obligation to deliver cash
or other financial asset think about
when you sell a bond when you sell a
bond when you raise money using bonds
guess what you're gonna have to pay
interest you're gonna have to transfer
or deliver cash to an to another party
for example the financial asset holder
is the financial asset holder
would receive the cash you would have a
financial liability why because now you
need to pay the cash so to notice of
notice maybe maybe this is this this is
interesting
notice financial liability it's gonna
ask you to deliver cash to or another
financial asset the let me just erase
this and highlight highlight financial
asset just show you it's kind of the
opposite of it if you look at financial
asset the definition of financial asset
it's the right to receive cash from from
another entity notice so one company
could have a financial liability the
other side will be defining the
financial asset okay or to exchange
financial asset or financial liabilities
under potentially unfavorable condition
again here here we're talking about
Kohl's an option but you might get it in
those calls and options okay also a
contract that will that will or maybe
settle in the entity own equity
instruments or sometimes you have to pay
off your liability using your own equity
instrument in other words you have a
debt you have a bond but what's gonna
end up happening is you're gonna pay off
that bond may be issuing some equity
instruments your own equity incident
that means it means your own company
stocks so you would exchange the bond
with with stocks that's what we are
talking about here example of financial
liabilities include payables payables
loans from other entities when you
borrow money you have a notes payable
when you borrow money you have a notes
payable notice the lender will have a
financial asset you will have a
financial liability the lender will have
a financial asset you will have a
financial liability issue bonds again
you issue the bond you have a financial
liability the person that buys the bond
will have a financial asset because they
have an investment in you other debt
instrument an obligation to deliver an
entity own share for a fixed amount of
cash again any debt that you're gonna
have to deliver stocks for which kind of
convertible that that's a financial
liability written put option when you
write a put option when you are
responsible for buying that put option
those who are financial liability equity
instruments were
equity instrument equity instruments are
defined as any contract that evidence a
residual interest in the asset and the
asset of an entity after deducting its
liability that's what an equity
instrument is but equity instruments one
that you know what does not include it
does not include which we talked about
this in addition to subsidiaries and
equity method investi so we talked about
subsidiaries and equity method invested
is's will you own 50% Plus this is where
you own between 50 2250 2250 used used
those method the following rx occluded
from the scope of is 32 insurance
contract that's not considered an equity
instrument and employers write an
obligation under employee pension plan
which is benefit plan which is a pension
that's not included we looked at this in
a separate recording shared base paid
share based payment program again we
looked at share base basement program
that's not equity instrument transaction
and the entity's own equity instruments
such as Treasury stock those are not
considered equity instrument okay now
let's take a look at some time what do
you have a liability or an equity so
some time you have an instrument and it
has the feature of a liability in
features of equity well let's talk about
a little bit about what is a liability
and what is in equity when we take when
we say liability it means you have that
what does that implies that implies you
have to pay back the money okay
so if you if I lend you money if I gave
you money
that's just I gave you money so there we
go you have two individuals okay this is
one and this is still I gave you money
and you gave me in return and instrument
now I don't know what what that
instrument is but we have a deal between
us and the deal says you're gonna pay me
I gave you money I gave you $100,000 and
here's what's gonna happen
you're gonna be paying me back making
payment making payments now you did not
define the payment I can't call those
payment interests I can't call those
payment dividend okay because I gave you
the money but we really did not define
the term whether its interest or
dividend but here's what's gonna happen
we
you told me in addition to the interest
and the payment you're gonna pay me back
this money $100,000 ten years from now
well guess what if you pay back the
money if you're gonna be paying me back
the money we have a loan we have a
liability okay but let's assume we're
not gonna pay me back the money I gave
you the money and you're gonna be
receiving interest and dividend and and
what's gonna happen is I'm gonna give
you some equity interest I'm gonna I'm
gonna let you vote I'm gonna let you
have a decision in my company then what
I have is an equity okay so the point is
you have to know what is the contractual
obligation here so you have to read the
agreement something if it's not clear to
determine whether we are dealing with an
equity instrument or a liability
insurance so I asked 30 to require
financial instrument to be classified as
financial liabilities am i buying at
that am i investing in that or am i
investing in equity or both in
accordance with or both or is it both
it's an equity and liability which we'll
see some some some instrument will be
both we have to look at the substance of
the contractual a great arrangement and
the definition of the financial
liability and equity if an equity
instrument contain a contractual
obligation that meets the definition of
a financial liability it means you'd
call in it it you'd call in it an equity
but it's not really in equity because
you have to give me back the money then
it should be classified as a liability
you might call something stocks like to
preferred stocks well guess what that
sounds like stock that sounds like
equity but if you said this is a
preferred stock and gonna give you back
your money
then it's not a preferred stock you
basically I gave you alone therefore
that's a liability even though it's
legal for is that of an equity
instrument so if it sounds if it sounds
like a liability but you call it equity
it's a liability okay for example if an
entity issue prefer chairs that are
redeemable redeemable means the
shareholder can come back at any time
and get their money back and the entity
cannot avoid the payment of the cash to
shareholder and the company cannot say
well am I gonna pay you back okay if
they redeem them you have no option you
have to give them back their money then
what you're looking at is a liability
not equity although you call them prefer
that well stock is equity but if I can
go back and ask you back for my money
it's not it's not equity anymore prefer
chairs are contingently redeemable based
on future event outside the control of
either the issue or the shareholder also
would be classified as a financial
liability sometime it's it's it's a
preferred stock but what happened is
it's redeemable if something happened so
if something happened I have I have the
right to go back and get my money back
well guess what
that's not stocks this is not how stocks
work this is not how equity work equity
basically once you make that investment
that's your investment you can't go back
to the mat you go back to the company
said I want my money back because you
did not lend them the money if a
preferred stock is contingently
redeemable contingently means if
something happened what could be an
example let's assume your stock price
your common stock price reaches a
certain number okay or falls below a
number or your retained earning false
above a number or below a number it's a
contingent upon something happening then
I can go back and get my money guess
what we're not looking at an equity
anymore this sounds like a liability so
if it sounds you can get your money back
it's a liability it's alone let's take a
look at an example to see how the Swart
on October 29th year one this company
issued 1 million five percent preferred
stock preferred shares at par value okay
the preferred shares have a right to
force the company to redeem the sheer at
par value so guess what you you well it
there's even a contingency if the
Federal Reserve Bank interest rate rise
above five percent to be more specific
so this is the contingency so the
company they have to buy it back from
you if the Federal Reserve Bank and tris
rise above five percent this is what a
contingent liability is well guess what
if it's contingent guess what is this a
stock or is this the death knell well
guess what now it said that why because
there is a contingency to remove - to
pay it back on December 10th the year 3
the Federal Reserve interest reaches
that level because a future event that
triggered redemption of the preferred
stock is outside the control of both the
company and the shareholder the 5%
preferred shares must be classified as a
liability therefore they will debit cash
a million and they will credit
redeemable preferred chair
a million okay under US GAAP it's
treated differently the preferred Cheers
initially would be classified as equity
then on December 10th year 3 what is
December 10th yeah what's December 10th
here 3 December 10th year 3 is when the
Federal Reserve raised the interest rate
to 5%
once that happened then we would
reclassify the liability so first under
US GAAP it will be a preferred stock so
you will debit cash under US GAAP you
have it cash and you will credit
preferred stock for the million then on
December 10th you will debit preferred
stock for a million and create a
liability why do you create a liability
because now it's a liability it's no
longer equity you have to take it out of
the preferred stock and put it into a
liability a bond or whatever you want to
call it whatever liability what I call
it I just call it a liability okay so
this is whenever you have either a
inequity or a liability this is how US
GAAP treated some time what we're gonna
have is a compound financial instrument
what's a compound financial instrument
it's a financial instrument that had the
future both of an equity and a liability
so we're looking at something that has
the feature of both well it has the
feature of an equity and it has a
feature of a liability what are we
looking at what are we looking at well
we're looking at for example convertible
bond okay compound financial instrument
can contain both alive out of the
element and an equity element should be
split between the two component that are
reported separately so now here what's
gonna happen is we have two instruments
although it's one contract although it's
one financial instrument but we really
have two things to account for this this
is what we call split accounting
convertible bond is a classic example
from it from a for a for a compound
financial instrument from the from the
issuers perspective the bond is
comprised of two components so when a
company sells a convertible bond guess
what they're selling you a contractual
obligation to make cash payment of
interest and principle as long as the
bond is not converted well guess what
they've given you a bond and they have
to pay you cash for the entry
and they have to pay you back your money
this sounds like a financial liability
that's a good that's that's part of the
bond the second part of it it has a cool
option that grant the bondholders right
to convert the bond into a fixed number
of common stock well this is an equity
instrument this is an equity instrument
hold on
so what is it is it that or asset
liability it's both it has the feature
it has the feature of both it has a bond
it's a bond you have to pick make
interest payment but also it has a call
option comes with it
okay under the split accounting the
initial carrying amount of the liability
and the equity are determined using what
we called with and without method so we
have to do as we act when we sell the
bond we're gonna get one price okay when
we sell the bond when we sell the
convertible bond when the company would
receive one price so they have to
determine how much of that money is for
the bond and how much that money is for
the call option for the equity component
the business it's an instrument that
it's a compound financial instrument
that has both it has a bond and the
liability not either or it has both okay
so the fair value of the financial
instrument with conversion feature is
determined so basically we'll try to
determine what is the fair value of the
whole of the whole deal so let's assume
for the whole deal here we said this is
I'm just gonna make up this number five
million dollars okay so so we sold the
bond at five million dollars and that
include the bond feature and the equity
feature then we'll try to determine the
fair value of the financial instrument
without the conversion feature then we
say okay if the whole thing is five
million dollar we're gonna will find the
we're gonna find the fair value of the
equity and we say the value of the
equity is two hundred thousand so we're
gonna subtract two hundred thousand from
the equity for the equity component so
we say the equity component is worth two
hundred thousand well guess what then
the bond is 4.8 million then the bomb
value is four point eight million so we
we take out the difference the
difference between the fair value of the
instrument as a whole and the amount
separately determined for the liability
component allocated to the equity
component well the two hundred thousand
as allocated to the equity we take it
out what's left for the bond
for the liability or the bond whatever
you want to call it liability or bond is
4.8 million this is what we do now an
under US GAAP we have the incremental
method we can use something called the
incremental method or the proportional
method similar but not the same okay
note that a compound financial
instrument is a financial asset for the
holder of the instrument so a few Bordas
okay if you bought this instrument if
you bought a convertible bond you have a
financial asset the company that issued
it will have a financial liability as I
told you what's financial asset for one
party is a financial liability for the
other let's take a look at an example to
see how this all worked Sharma
corporation issued two million 4%
convertible bond notice its convertible
the bond has a five year life with
interest payable annually so so far so
good
each bond has a face value of $1,000 and
s convert is converted at any time up to
maturity for 250 shares of common stock
so the bond holder bought the bond okay
but guess what this one is great why
because if the company is doing really
well you can convert the bond you can
convert each bond for shares that's a
convertible bond so it has a bond it has
a liability feature I'm gonna get my
interest then the company said look if
you like to switch themes and go from
being a lender to an owner we can get we
you do have that right we have you have
that convertible right now you might be
saying why would the company do so why
would the company sell a bond that gives
you the right to convert well guess what
when you sell a bond and the company
have tried to convert the bond it's
gonna the company will pay lower
interests in other words they're givin
you an additional feature so the company
don't have to pay a high interest so
here what they pay in is 4% maybe
without the feature they might have to
pay 8% or 7% so what they say they say
we'll pay you four percent anyway you
might you might tell them this is too
low I'm not gonna buy your bond well I'm
gonna pay you four percent and I'm gonna
tell you this bond is convertible
anytime you would like to convert it you
can't convert it well that's that's a
good feature then now I might accept the
4% okay at the date of the issue the
interest rates were similar that without
conversion is 6% there you go
so if that
the FDA if the convertible feature did
not exist if the convertible feature
does not exist for the spawn the company
would have to pay 6% rather than 4% okay
now we have to find because we have both
a debt and equity we have to find how
much of the bond is that and how much of
it is equity now what do we do well we
know the bond should have a 6% interest
rate so what we're saying is the bond
should earn interest rate at 6% then we
have to find the fair value of the bond
that we sold at 2 million well if we
sold the bond at 2 million okay we're
gonna have to find the price of the bond
to find the price of the bond you have
to discount the 2 million you have to
discount the principal and you have to
discount the payment let me show you the
computation okay we're gonna take the
principal amount and this is how we find
the price of the bond multiplied by the
present value factor point seven four
seven three five periods interest rate
equal to 6% we use the interest rate
that the market that the interest rate
for similar bond will paying so the bond
is worth the face value of the bond is
worth 1 million four hundred ninety four
thousand five sixteen then we have to
find the payment on that bond the
payment is eighty thousand why eighty
thousand because the bond is two million
dollar and paying eight percent times
with interest payable annually
I'm sorry paying four percent eight
percent times four percent so every year
the bond pays eighty thousand and this
is gonna be five payments we're gonna
make five payments on this bond why cuz
it's five years therefore when we go to
the present value annuity table we use
an equal to five and we always use the
market rate 6% therefore we discount the
eighty thousand had that factor
therefore the bond by itself so remember
we have the bond and the call option the
bond by itself the fair value of the
liability is 1 million eight hundred
thirty one thousand five fifteen this is
the bond the bond on its own
on its own let me go back to that
example here let me go back to that
example here and show you the picture so
what happened here let me erase
everything then show you on the picture
what does it look like
so we're saying what we saying is we
receive 2 million for the whole thing
then we determine the value of the bound
the value of the bond was 1 million
eight hundred thirty one thousand 505
based on the present value of the
principal based on the present value of
the payment now if you don't know how to
do this computation well you're gonna
have to you know go to my intermediate
accounting bond bond the bond
computation which is chapter fourteen
and in my intermediate accounting if you
don't know how to do this so what's left
for the for the other section is one
sixty eight four ninety five so this is
1 million eight hundred thirty one
thousand 505 and the equity portion is
worth one hundred sixty eight thousand
four ninety five so we know the total
and we know the bond sometimes we know
the total and we can know the equity
okay good now we know the bond now let's
take a look at the journal entry the
journal entry the company will debit
cash two million they will credit bonds
payable for 1 million eight hundred
thirty one thousand five or five and
remainder will go to additional paid-in
capital now under US GAAP the entry
would look little bit different okay
because we might have a discount you
might have a premium but this is
basically it's just an idea to help you
move on to understand the compound
financial instrument okay now if you
have any issues with bond okay any
issues with bond like yeah I really
don't understand bond especially if he
if this is if this was confusing to you
this this computation here was confusing
to you what I did here well over for
what I did here is confusing go to
chapter fourteen intermediate accounting
okay now if you feel that this those
factors was this coming from point seven
seven four seven three those are
intimidating to me I don't I don't
understand how it works then go to my
intermediate accounting chapter
six chapter six stop talks about
discusses the time value of money which
is I have three four hours of lectures
and examples and if you don't know how
the time value of money work then you
should not be in accounting okay or you
should not be studying accounting or you
should go back learning time value of
money because we're gonna see this
concept in pent and leases and pension
and bonds and anything and everything
okay why because the time value of money
is an important concept if you have any
questions about this recording please
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for your ACCA a or CPA exam study hard
it's worth it good luck and see you on
the other side of success
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