Question

a) Kunal plc issued £6 million 6% convertible bonds on 1 January 2017 at par. The bonds are redeemable at par on 31 December 2020 or convertible at that date on the basis of 120 £1 ordinary shares for every nominal £100 of bonds. At the date of issue the prevailing market rate for similar debt without conversion rights was 8%. The interest due was paid on 31 December 2017 and recorded within finance costs during the year. Required: Explain how convertible instruments are initially recognised in accordance with IFRS7 Financial Instruments: Presentation, and prepare the journal entry to record the issue of the bonds by Kunal plc. Note: Extracts from the present value table (present value of £1 per annum, receivable or payable at the end of each year for n years): Interest rates 7% 5% 6% 8% 9% Years (n) O AWN 0.952 0.907 0.864 0.823 0.784 0.943 0.890 0.840 0.792 0.747 0.935 0.873 0.816 0.763 0.713 0.926 0.857 0.794 0.735 0.681 0.917 0.842 0.772 0.708 0.650 Extract: Cumulative present value table: Years 5% 6% 7% 8% 9% (n) 0.952 1.859 2.723 3.546 4.329 0.943 1.833 2.763 3.465 4.212 0.935 1.808 2.624 3.387 4.100 0.926 1.783 2.577 3.312 3.993 0.917 1.759 2.531 3.240 3.890

Answer 1

Answer-a:

Convertible bonds are basically debt instruments but they also contain an option to convert into equity shares and this means that a convertible bond contains both debt and equity elements.

For accounting purposes it will be necessary on initial recognition to split out the debt and equity elements so that they can be separately accounted for. The fair value of the option is highly subjective, but the fair value of the debt element is more easily measured by discounting the future cash flows. The assumption is then made that the fair value of the option is the balancing figure.

PV of the Cash flow Discount Year future (60,00,000*6%) factor cash flow 360000 0.926 £ 3,33,360 2 360000 0.857 £ 3,08,520 3 360000 0.794 £ 2,85,840 4 6360000 0.735 E 46,74,600 Fair value of the Debt instruments £ 56,02,320 Equity element (Bal. fig.) £ 3,97,680 Proceeds of the issue E 60,00,000

Credit Debit £ 60,00,000 Account Cash Financial liability Equity |(to record initial recognistion of issue of bond) £ 56,02,320 £ 3,97,680

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