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Financial instruments
7.3 Embedded derivatives
IFRS 9 says that an embedded derivative is a component of a contract
that includes a non-derivative host and which affects cash flows in a
similar way to a standalone derivative.
If the host contract is in the scope of IFRS 9 Financial Instruments then the entire
contract must be classified and measured in accordance with that standard.
Example 12
Investment in convertible bond
An entity purchases a convertible bond and will receive interest of 3% annually
in arrears. The bond can be redeemed in the form of cash or a fixed number of
equity shares in three years’ time. Market rates of interest are 10%.
Explain how the entity should measure the bond.
If the host contract is not in the scope of IFRS 9 Financial Instruments then entities
are permitted to account for the host and derivative elements separately (as long as
certain conditions are met). However, this is complex. As such, entities are permitted
to measure the contract at fair value through profit or loss in its entirety.
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