Cheery Company follows IFRS for its financial reporting. On January 1, 2015 Cheery issued €250 million of 10-year convertible notes that pay interest at 5% annually. Investors pay €250 million for the notes even though the company's credit risk at the time implies a 10% interest rate for traditional debt of similar duration. When the cash flows associated with the debt are discounted at 10%, the resulting value is €175 million.
-On Cheery's December 31,2015 income statement how much interest expense will be recorded?

Question

Quizplus · Accepted Answer

The interest expense recorded on the income statement will be €17.5 million. This is because under IFRS, the liability component of the convertible notes is measured at the present value of its future cash flows discounted at the market rate of interest at issuance (10% in this case), which is €175 million. The annual interest expense is then calculated using the effective interest rate method, which in this case is 10% of €175 million, resulting in €17.5 million.

Cheery Company Follows IFRS for Its Financial Reporting