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HMRC internal manual

Corporate Finance Manual

HM Revenue & Customs
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Accounting for corporate finance: hybrid debt: comparison of compound and hybrid financial instruments

Differences between compound and hybrid financial instruments

There is a superficial similarity between separating a compound financial instrument into liability and equity components (CFM21260), and separating a hybrid financial instrument into a host contract and an embedded derivative (CFM25030), so that it is possible to confuse the two. The table below summarises the differences.

Compound financial instrument Hybrid financial instrument
  • a financial liability, and
  • an equity component Comprises
  • a host contract (which may be a financial asset, financial liability or neither), and
  • one or more embedded derivatives    
      Dealt with by IAS 32, FRS 25 under Old UK GAAP and Section 22 of FRS 102 Dealt with by IAS 39 and FRS 26 under Old UK GAAP.
      Separation required in all cases, irrespective of the accounting framework adopted. Separation required under IAS 39 and FRS 26 only where certain conditions are met (CFM25040).
Separation not required in FRS 102 unless an entity chooses to apply IAS 39. Typically the whole instrument would be fair valued.    
  Equity component measured on initial recognition as the difference between the fair value of the instrument as a whole, and the fair value of the liability; not subsequently remeasured. Where separation required under IAS 39 or FRS 26, embedded derivative is measured at fair value.

A ‘plain vanilla’ convertible bond, which converts into shares of the issuing company, will be

  • a compound financial instrument of the issuer, and
  • a hybrid financial instrument of the holder.

Because compound and hybrid financial instruments are accounted for in different ways, you would not necessarily expect symmetry between the amounts going through the income statement of the issuer, and those going through the income statement of the holder.