Where did they get the present value number!? Are we suppose to calculate this ourselves?
Simms Corporation reports under IFRS. Simms issued 2,000 $1,000 convertible bonds at par, with an annual interest rate of 5% when the market was 8%. The bonds are due in 5 years and each $1,000 bond is convertible into 3 shares of common stock. At what amount would Simms record the equity component of the bond?
$ 6,000
$ 239,569
$1,760,431
$2,000,000
ANSWER>
Under IFRS, convertible debt must be separated into its debt and equity components. To do this, discount the bond at market interest rates as in US GAAP. The liability component is the discounted amount and the equity component is the residual of the cash received less the discounted amount. Calculations are as follows:
Face amount of the bonds: 2,000 × $1,000 = $2,000,000
Present value of $1 for the principal ($2,000,000 × 0.68058) = $ 1,361,160
Present value of an ordinary annuity for the interest ($100,000 × 3.99271) = $ 399,271
Value of the liability = $ 1,760,431
Value of the equity ($2,000,000 – $1,760,431) = $ 239,569
Journal entry at issuance:
Cash $2,000,000
Bonds Payable $1,760,431
Equity – conversion option $239,569
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