FR exam practice question 2

Financial Reporting exam practice question

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The correct answer is the fourth option.

Explanation.

Option 4 is correct because IFRS 9 requires the separate measurement of the component parts. IAS 32 requires entities to first measure the value of the liability component, and the difference between the fair value of the instrument and the liability value is allocated to the equity component.

Option 1 is incorrect because IAS 32 requires issuers of instruments such as convertible notes to classify the components as: a financial liability (a contractual arrangement to deliver cash or other financial assets); and as an equity instrument (an option to buy shares of the issuer).

Option 2 is incorrect because once the component parts are recognised in the statement of financial position, the classification is not revised, irrespective of the probability of conversion of the right to purchase shares. Once the issuer classifies the component parts of a convertible note as a liability and equity, the amounts do not change until extinguished through conversion or settlement at maturity.

Option 3 is incorrect because component parts of a compound financial instrument are separately classified (IAS 32, para. 28). According to IAS 32, it is more a matter of form than substance that liabilities and equity interests are established by one financial instrument rather than two or more separate instruments.