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Chapter
24 /
Financial In struments : Presentation
(lAS
32 )
227
Practical
Insight
Instruments that from the issuer' s perspective have both liability and equity elements are from
the holder ' s perspecti ve often financial assets that contain embedded derivatives under lAS 39.
However, split accounting under lAS 32 is different from embedded derivatives accounting
under lAS 39, because under lAS 39 an embedded deri vative is separated and accounted for as
a financial asse t or financial liability at fair value, while under lAS 32, an embedded derivative
that meet s the definition of an equity instrument is classified and presented as own equity.
3.2.2 By requi ring split accounting for the components of compound instruments, lAS 32 ensures
that financial liabilities and equity instruments are accounted for in a consis tent manner irrespective
of whether they are transacted together in a single, compound instrument (e.g., a conve rtible bond)
or transacted separately as two freestanding contrac ts (i.e., a bond and an issued share warrant).
3.2.3 To determine the initial carryi ng amounts of the liabil ity and equity components, entities
apply the so-called with-and-wit hout method. The fair value of the instrument is determined first
includ ing the equity component. The fair value of the instrument as a whole generally equals the
proceeds (considera tion) received in issuing the instrument. The liabilit y component is then mea–
sured separately without the equity component. The equity component is assigned the residual
amount after deducting from the fair value of the compound instrument as a whole the amount
separately determin ed for the liability component. That is
Fair value of compound instrument
- Fair value of liability component
(=
its initial carrying amount)
=
Initial carrying amount of equity component
3.2.4 The opposite is not permitted; that is, it is not approp riate to determ ine the fair value of the
equity compone nt first and then allocate the residual to the liability component.
3.2.5 The sum of the initia lly recognized carrying amounts of the liability and equity components
always equals the amount that would have been assigned to the instrument as a whole.
Example
Entity A issues a bond with a principal amount of $100,000. The holder of the bond has the right to
convert the bond into ordinary shares of Entity
A . 011
issuance, Entity
A
receives proceeds of
$100,000. By discounting the principal and interest cash fl ows of the bond using interest rates for
similar bonds without an equity component, Entity
A
determines that the fa ir value of a similar bond
without any equity component would have been $91,000. Theref ore, the initial carrying amount of
the liability component is $91,000. The initial carrying amount of the equity component is computed
as the difference between the total proceeds (fair value) of$100,000 and the initial carrying amount
of the liability component of $91,000. Thus, the initial carrying amount of the equity component is
$9,000. Entity A makes this journal entry:
Dr
Cash
100,000
Cr Financial liability
91,000
Cr Equity
9,000
3.2.6 The subsequent accounting for the liability component is gove rned by lAS 39, For instance,
if the liabilit y component is measured at amorti zed cost, the difference between the initial carrying
amount of the liability component ($91,000 in the example) and the principal amount at maturit y
($100,000 in the example) is amortized to profit or loss as an adjustment of interest expense in ac–
cordance with the effective interest method. This has the effec t of increasing interest expense as
compared with the stated interest rate on the bond,
3.2.7 The accounting for the equity component is outside the scope of lAS 39. Equity is not re–
meas ured subsequent to initial recogn ition.
3.2.8 Classification of the liability and equity components of a convert ible debt instrument is not
revised as a result of a change in the likelihood that the equity conversion option will be exercised.