COMPOUND
FINANCIAL
INSTRUMENTS
Compound Financial Instruments
Problem No. 7-1
At the beginning of the current year, Monic Co. decided to issue 5,000, 10-year bonds of
8%, P1,000 face amount each with warrants to acquire share capital at P30 per share.
The interest on the bonds is payable annually every December 31.
Each bond contains one warrant which can be used to acquire 4 shares of 25 par value
share capital. It is reliably determined that without the warrants, the bonds would sell at
114.7 with a 6% effective yield. The bond price with warrants is 120. All warrants were
exercised at year-end.
REQUIRED:
Prepare the journal entries for the current year in connection with the bond issuance
and the exercise of the warrants. Use effective interest method of amortization.
Cash
Bonds payable
6,000,000
Premium on bonds payable
Share warrants outstanding
(To record the issuance of the bonds with warrants)
5,000,000
735,000
265,000
Issue price with warrants (P 5,000,000 x 120%)
M arket price of bonds without the warrants (P 5,000,000 x 114.7%)
Equity component (share warrants outstanding)
6,000,000
(5,735,000)
265,000
M arket price of bonds without the warrants (P 5,000,000 x 114.7%)
Face amount of the bonds
Premium on bonds payable
5,735,000
(5,000,000)
735,000
Compound Financial Instruments
Problem No. 7-1
At the beginning of the current year, Monic Co. decided to issue 5,000, 10-year bonds of
8%, P1,000 face amount each with warrants to acquire share capital at P30 per share.
The interest on the bonds is payable annually every December 31.
Each bond contains one warrant which can be used to acquire 4 shares of 25 par value
share capital. It is reliably determined that without the warrants, the bonds would sell at
114.7 with a 6% effective yield. The bond price with warrants is 120. All warrants were
exercised at year-end.
REQUIRED:
Prepare the journal entries for the current year in connection with the bond issuance
and the exercise of the warrants. Use effective interest method of amortization.
Interest expense
Cash
(To record the payment of nominal interest for the year)
400,000
400,000
Premium on bonds payable [ (P5,735,000 x 6%) - P400,000 ]
55,900
Interest expense
(To record the amortization of premium on bonds payable for the year)
Cash ( 5,000 warrants x 4 shares x P30/share )
Share warrants outstanding
Share capital (5,000 warrants x 4 shares x P25/share )
Share premium - issuance
(To record the exercise of the warrants)
55,900
600,000
265,000
500,000
365,000
Compound Financial Instruments
Problem No. 7-3
At the beginning of the current year, Zamboanga Co. issued Php 8,000,000 of 12% bonds
payable maturing in 5 years. The bonds pay interest semi-annually on June 30 and
December 31.
The bonds include share warrants giving the bondholder the right to purchase 16,000
P100 par value shares for P150 per share within the next three (3) years. The bonds and
warrants were issued at 120. The value of the warrants at the time of issuance was Php
1,500,000. All share warrants were exercised at current year-end. The market rate of
interest for similar bond without the warrants is 10%. The PV of 1 at 5% for ten (10) periods
is 0.61 and the PV of an ordinary annuity of 1 at 5% for ten (10) periods is 7.72.
REQUIRED:
Prepare the journal entries for the current year in connection with the bond issuance
and the exercise of the warrants. Use effective interest method of amortization.
1/1 Cash
Bonds payable
9,600,000
8,000,000
Premium on bonds payable
Share warrants outstanding
(To record the issuance of the bonds with warrants)
585,600
1,014,400
Issue price of the bonds with share warrants (P8,000,000 x 120%)
Fair value of the bonds, without the warrants:
9,600,000
Present value of principal (P8,000,000 x 0.61)
4,880,000
Present value of interest payments (P8,000,000 x 6% x 7.72) 3,705,600
Equity component (share warrants outstanding)
(8,585,600)
1,014,400
Compound Financial Instruments
Problem No. 7-3
At the beginning of the current year, Zamboanga Co. issued Php 8,000,000 of 12% bonds
payable maturing in 5 years. The bonds pay interest semi-annually on June 30 and
December 31.
The bonds include share warrants giving the bondholder the right to purchase 16,000
P100 par value shares for P150 per share within the next three (3) years. The bonds and
warrants were issued at 120. The value of the warrants at the time of issuance was Php
1,500,000. All share warrants were exercised at current year-end. The market rate of
interest for similar bond without the warrants is 10%. The PV of 1 at 5% for ten (10) periods
is 0.61 and the PV of an ordinary annuity of 1 at 5% for ten (10) periods is 7.72.
Fair value of bonds without the warrants
Face amount of the bonds
Premium on bonds payable
8,585,600
(8,000,000)
585,600
6/30 Interest expense (P8,585,600 x 5%)
429,280
Premium on bonds payable (P480,000 - P429,280)
50,720
Cash
(To record the nominal interest for the period and amortization of premium)
12/31 Interest expense { [ (P8,585,600 x 1.05%) - P480,000 ] [5%] }
426,744
Premium on bonds payable (P480,000 - P426,744)
53,256
Cash
(To record the nominal interest for the period and amortization of premium)
Cash ( 16,000 shares x P150/share )
Share warrants outstanding
Share capital (16,000 shares x P100/share )
Share premium - issuance
(To record the exercise of the warrants)
480,000
480,000
2,400,000
1,014,400
1,600,000
1,814,400
Compound Financial Instruments
Problem No. 7-10
Armada Co. issued Php 5,000,000 face amount, 5-year bonds at 109. Each Php 1,000
bond was issued with 10 share warrants, each of which entitled the bondholder to
purchase one share of Php 100 par value at Php 120. Immediately after issuance, the
market value of each warrant was Php 5.
The stated interest rate on the bonds is 11% payable annually every end of the year.
However, the prevailing market rate of interest for similar bonds without warrants is 12%.
The present value of 1at 12% for 5 periods is 0.57 and the present value of an ordinary
annuity of 1 at 12% for 5 periods is 3.60.
REQUIRED:
1. What is the carrying amount of the bonds payable on the date of issuance?
2. What amount should be recorded initially as discount or premium on the bonds?
3. What is the equity component arising from the issuance of the bonds payable?
4. What amount is credited to share premium if all of the share warrants were
exercised?
Compound Financial Instruments
Problem No. 7-10
Armada Co. issued Php 5,000,000 face amount, 5-year bonds at 109. Each Php 1,000
bond was issued with 10 share warrants, each of which entitled the bondholder to
purchase one share of Php 100 par value at Php 120. Immediately after issuance, the
market value of each warrant was Php 5.
The stated interest rate on the bonds is 11% payable annually every end of the year.
However, the prevailing market rate of interest for similar bonds without warrants is 12%.
The present value of 1at 12% for 5 periods is 0.57 and the present value of an ordinary
annuity of 1 at 12% for 5 periods is 3.60.
REQUIRED:
1. What is the carrying amount of the bonds payable on the date of issuance?
2. What amount should be recorded initially as discount or premium on the bonds?
3. What is the equity component arising from the issuance of the bonds payable?
4. What amount is credited to share premium if all of the share warrants were
exercised?
Compound Financial Instruments
Problem No. 7-5
Sunshine Co. issued 4-year, 12% convertible bonds with face amount of Php 5,000,000 at
105 on January 01, 2020 maturing on January 01, 2025 and paying interest annually on
December 31. It is reliably determined that the bonds would sell at Php 4,700,000
without the conversion feature with an effective yield of 14%.
Each Php 1,000 bond is convertible into 8 shares of Php 100 par value share capital. On
December 31, 2020, all of the bonds are converted into share capital. At this time, the
share has a market value of Php 150 and the bonds are quoted at 101.
REQUIRED:
1. Prepare journal entry to record the issuance of the bonds on January 01, 2020.
2. Prepare journal entry to record the interest payment and amortization for 2020. The
effective interest method of amortization is used.
3. Prepare journal entry to record the conversion of the bonds on December 31, 2020.
Compound Financial Instruments
Problem No. 7-5
Sunshine Co. issued 4-year, 12% convertible bonds with face amount of Php 5,000,000 at 105 on
January 01, 2020 maturing on January 01, 2025 and paying interest annually on December 31.
It is reliably determined that the bonds would sell at Php 4,700,000 without the conversion
feature with an effective yield of 14%.
Each Php 1,000 bond is convertible into 8 shares of Php 100 par value share capital. On
December 31, 2020, all of the bonds are converted into share capital. At this time, the share
has a market value of Php 150 and the bonds are quoted at 101.
REQUIRED:
1. Prepare journal entry to record the issuance of the bonds on January 01, 2020.
2. Prepare journal entry to record the interest payment and amortization for 2020. The effective
interest method of amortization is used.
3. Prepare journal entry to record the conversion of the bonds on December 31, 2020.
Compound Financial Instruments
Problem No. 7-6
Karen Co. showed the following accounts on December 31, 2020:
Bonds payable
Premium on bonds payable
Share capital – 250,000 shares authorized and
200,000 shares issued, P50 par
Share premium - issuance
Share premium – conversion privilege
Retained earnings
5,000,000
250,000
10,000,000
2,000,000
500,000
2,500,000
The bonds are convertible into 10 shares of capital for every Php 1,000 bond. On
December 31, 2020, the entire bond issue was converted and on this date, the market
value of the share is 120 and the market value of the bonds is 103. The entity paid Php
200,000 as a result of the bond conversion.
REQUIRED: Prepare journal entries for the conversion of the bonds on December 31, 2020.
Compound Financial Instruments
Problem No. 7-8
On January 1, 2020, Arlene Co. issued convertible bonds with face amount of Php
5,000,000 for Php 6,000,000. The bonds are convertible into 50,000 shares with Php 100
par value.
The bonds have a 5-year life with 10% stated interest rate payable annually every
December 31. The fair value of the convertible bonds without the conversion option is
computed at Php 5,399,300 on January 1, 2020. On December 31, 2022, the convertible
bonds were not converted but fully paid for Php 5,500,000. On such date, the fair value
of the bonds without conversion privilege is Php 5,400,000 and the carrying amount is
Php 5,178,300.
REQURIED:
1. Prepare journal entry to record the original issuance of the convertible bonds on
January 1, 2020.
2. Prepare journal entries on December 31, 2022.
1
Cash
Bonds payable
Premium on bonds payable
Share premium - conversion privilege
(To record the issuance of convertible bonds)
6,000,000
5,000,000
399,300
600,700
Issue price with conversion privilege
M arket price of bonds without the conversion privilege
Equity component (share warrants outstanding)
6,000,000
(5,399,300)
600,700
M arket price of bonds without the conversion privilege
Face amount of the bonds
Premium on bonds payable
5,399,300
(5,000,000)
399,300
Compound Financial Instruments
Problem No. 7-8
REQURIED:
1. Prepare journal entry to record the original issuance of the convertible bonds on
January 1, 2020.
2. Prepare journal entries on December 31, 2022.