Question

Which of the following statements is correct?

a) IFRS separates the proceeds of a convertible bond between debt and equity by determining the fair value of the debt component before the equity component.

b) Both IFRS and GAAP assume that when there is a choice of settlement of an option for cash or shares, share settlement is assumed.

c) IFRS separates the proceeds of a convertible bond between debt and equity, based on relative fair values.

d) Both GAAP and IFRS separate the proceeds of convertible bonds between debt and equity.

Short answer

Correct option: a. IFRS separates the proceeds of a convertible bond between debt and equity by determining the fair value of the debt component before the equity component.

Step-by-step solution

The explanation for the correct option

In the IFRS, all the convertible bonds are separated, which implies a partition into the value part of a bond issue and a debt component. The IFRS additionally states that there should be a different distinguishing liability and equity, and treat them in accordance with the financial statements. Because of the accessibility of a conversion option, convertible bonds carry lower interest rates than an ordinary debt.

The explanation for the incorrect options    

Option b: Both the IFRS and the GAAP accept that when there is a decision of repayment of an option for cash or shares, the expectations of a share repayment is an incorrect statement.

Option c: The IFRS does not separate the proceeds of a convertible bond between a debt and an equity based on relative fair values.

Option d: Both the GAAP and the IFRS do not separate the proceeds of convertible bonds between a debt and an equity.