Question

4) An 8% $30 million convertible loan note was issued on 1 April 20X5 at par. Interest is payable in arrears on 31 March each year. The loan note is redeemable at par on 31 March 20X8 or convertible into equity shares at the option of the loan note holders on the basis of 30 shares for each $100 of loan. A similar instrument without the conversion option would have an interest rate of 10% per annum. The present values of $1 receivable at the end of each year based on discount rates of 8% and 10% are: 8% 10% End of year 1 0.93 0.91 0.86 0.83 3 0.79 0.75 What amount will be credited to equity on 1 April 20X5 in respect of this financial instrument?

Answer 1

In convertible notes, accounting for issue should be done by split between liability portion and equity portion.
Liability portion is the present value of the future cash flows, calculated by discounting the future cash flows of the bond (interest and principal) at the market rate of interest with the assumption that no conversion option is available. (in this example 10%)
First we will calculate liability portion of convertible bonds
Year	Date	Type of payment	Cashflow	Discounting factor (10%)	Present value of cash flow
1	31-Mar	Interest	2400000	0.91	2184000
2	31-Mar	Interest	2400000	0.83	1992000
3	31-Mar	Interest	2400000	0.75	1800000
3	31-Mar	Principal repayment	30000000	0.75	22500000
			Present value	28476000
	Interest payment = $ 30000000 *8% = $ 2400000
Equity portion will be differnece between proceeds received from issue of convertible notes and liability portion as calcualted above
So Equity portion = $ 30000000 - $ 28476000 = $ 1524000
Amount $ 1524000 will be credited to equity on April 1, 20X5