Accounting for corporate finance: liability and equity: accounting treatment
Accounting for compound financial instruments
The split between the liability and equity components of a compound financial instrument is done on issue and is not subsequently revised, even when exercise of the conversion option becomes more likely.
The company must, on initial recognition
- measure the fair value of the compound instrument as a whole
- measure the fair value of the liability component, and
- assign a value to the equity component by deducting from the fair value of the instrument as a whole the amount separately determined for the liability component.
No gain or loss arises on initial recognition. CFM21270 gives an example of the process.
Thereafter, the liability component is measured in accordance with the measurement requirements for financial liabilities of IAS 39 (for IFRS or FRS 101 users) and Section 11 and Section 12 (for FRS 102 users who have not adopted the IAS 39 or IFRS 9 policy choice) - i.e. at FVTPL or amortised cost, with changes going through the profit and loss account. On conversion of a convertible, the company derecognises the liability component and recognises it as equity. The original equity component remains as equity (although it may be transferred from one line item within equity to another). There is no gain or loss on conversion at maturity.