Bay Ltd issued $20 million of convertible notes on 1 July 2022. The notes have a life of 6 years and a face value of $20 each. Annual interest of 5% is payable at the end of each financial year. The notes were issued at their face value and each note can be converted into one ordinary share in Bay Ltd at any time over their lives. Organizations with a similar risk profile to Bay Ltd have issued debt with similar terms but without the option to convert at the rate of 7%.

Required

A) Assume the holders of the convertible notes elect to convert the notes to ordinary shares at the end of the first year of the notes. Provide the appropriate accounting entries to record these events in the general journal of Bay Ltd.

B) Paragraph15ofAASB132/IAS32requiresdistinguishingbetweenfinancialliabilitiesandequityinstrumentsfor the issuing entity.However,Ingeneral, theissuing entity,includingBayLtd,willpreferanequityclassification.Brieflydiscuss why firmsprefertoclassifyafinancial instrument as an equity instrument rather than financial liabilities