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ACCA Applied Skills · Financial Reporting · Financial instruments

On 1 January, Orion Co issues 10 million $1 convertible bonds at par. They pay 5% interest annually in arrears and are redeemable at par after 3 years or convertible into shares. The market rate for similar non-convertible debt is 8%. Discount factors at 8% for years 1, 2 and 3 are 0.926, 0.857 and 0.794 respectively. What amount is credited to equity on issue?

The equity component is $771,500. The liability is the present value of interest of $500,000 a year plus $10 million principal, discounted at 8%, which equals $9,228,500. Deducting this from the $10 million proceeds leaves $771,500 as the residual credited to equity.

  1. A$771,500Correct
  2. B$9,228,500
  3. C$7,940,000
  4. D$1,288,500

Explanation

Annual interest is 500,000. PV of interest = 500,000 × (0.926+0.857+0.794 = 2.577) = 1,288,500. PV of principal = 10,000,000 × 0.794 = 7,940,000. Liability = 9,228,500, so equity = 10,000,000 − 9,228,500 = 771,500. The option $9,228,500 is the liability, not the equity.

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