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F2: Advanced Financial Reporting

3.4 $3,955,000

Initial recognition of financial liability

$000
Par value 4,000
Discount (2.5%) (100)
Transaction costs (200)
––––––

3,700

Per IAS 39, financial liabilities are held at amortised cost as at the year end.
Therefore, for y/e 31st December 20X6 (figures given in $000’s):

Interest at
effective IR Repayment
b/f (8.71%) @ coupon c/f
20X5 3,700 322 (200) 3,822
20X6 3,822 333 (200) 3,955

3.5 C

The convertible bonds should be initially recognised partly as equity and partly
as a liability.

The initial liability component is calculated as follows:

Present value of coupon payments of 3% for four years, $2m x 3% × 3.387 =
$203,220

Present value of principal after 4 years, $2m × 0.763 = $1,526,000

Total liability component = 203,220 + 1,526,000 = $1,729,220

The liability element is then shown at amortised cost over the four year period
up to redemption/conversion and this creates the finance cost.

Therefore the finance cost = 7% × $1,729,220 = $121,045.

Exam tip – This answer can be arrived at by a process of elimination rather than
precise calculation. Interest at the effective interest will never be nil if the
coupon rate is 3%. As the initial liability will be less than $2m you can eliminate
both options 2 and 4, which are 3% and 7% respectively of $2m. This leaves
option C only.

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