ABC Ltd issued $10 million convertible bonds on 1 July 2021 that carry a nominal interest (coupon) rate of 5% per annum. They are redeemable on 30 June 2024 for cash or can be exchanged for ordinary shares in ABC Ltd on the basis of 20 shares for each $100 of a bond. The prevailing market interest rate for the bonds without conversion options are 8%.

When preparing the draft financial statements for the year ended 30 June 2022, the directors are proposing to show the convertible bond within equity in the statement of financial position, as they believe all the convertible bond holders will choose the equity option when the convertible bond is due for redemption. They further intend to charge a finance cost of $500,000 ($10 million x 5% per annum) in the income statement for each year up to the date of redemption.

Required:

a) Briefly comment on the impact of the directors proposed treatment of the convertible bonds on the financial statements and do you think this treatment is ethically acceptable. b) Calculate the present value of bond liability and equity component on 1 July 2021.

c) Prepare the necessary journal entries on 1 July 2021 and 30 June 2022.

d) Prepare an extract to show how the convertible bonds and equity component should be presented by ABC Ltd in its statement of financial position for the year ended 30 June 2022.