Financial Instruments - Debt + Equity (Compound Instrument)

Once you have calculated the equity element at the inception of the agreement, that's it! The present value of the debt is credited to the loan and the balance difference between that present value of the debt when compared with the face value of the loan is the equity element credited to "other components of equity" and there it shall stay forever more! Interest paid in arrears? If you think about this logically ALL interest is paid in arrears ... ... except in those situations where it is stated to be paid in advance but even then, ignoring for one moment the very first payment, interest is paid in arrears Consider this: Loan taken on 1 January, 2004 $40,000 Interest at 10% paid in arrears (I'm ignoring the loan repayment - I don't need it to illustrate the point) 31 December, 2004 pay whatever is the capital amount + interest Now what if the interest is paid in advance? Loan taken on 1 January, 2004 $40,000 Interest at 10% paid in advance (I'm ignoring the loan repayment - I don't need it to illustrate the point) 1 January, 2004 pay a capital amount? Maybe, but that simply reduces the amount of loan outstanding Pay interest amount? Unlikely - you only borrowed the money 2 minutes ago! So that first payment of whatever amount is all capital and reduces the amount borrowed The next payment in this agreement pays some capital and the interest accrued on that reduced level of borrowing and, even though the agreement may say it's payable in advance, it's actually paid in arrears, isn't it? Surely 1 January, 2005 payment date is no different than 31 December, 2004 Yes, it affects the financial statements particularly where it's a 31 December year end but that's all Look at the examples of Giedrius and Giedruola in the leases chapter of the free F7 course notes and try to follow those through