ABC Ltd is an Australian company issued $10 million convertible notes on 1 July 2019 that carry a nominal interest (coupon) rate of 5% per annum. They are redeemable on 30 June 2022 for cash or can be exchanged for ordinary shares in ABC Ltd on the basis of 20 shares for each $100 of note. The prevailing market interest rate for the notes without conversion options are 8%. When preparing the draft financial statements for the year ended 30 June 2020, the directors are proposing to show the convertible note within equity in the statement of financial position, as they believe all the convertible note holders will choose the equity option when the convertible note is due for redemption. They further intend to charge a finance cost of $500,000 ($10 million x 5%) in the income statement for each year up to the date of redemption.

a) What is a compound or hybrid financial instrument? Please provide two examples of a compound or hybrid financial instrument. (4 marks)

b) Briefly comment on the impact of the directors proposed treatment of the convertible notes on the financial statements and the acceptability of this treatment. (4 marks)

c) Prepare extracts to show how the convertible notes and the finance charge should be treated by ABC Ltd in its financial statements for the year ended 30 June 2020. Show your workings