Question

Question) On 1 July 2020, Tierny issues 5,000 convertible notes to enable construction of a facility to train security guards. The notes have a three year term and are issued at par with a FV of $10,000 per note, giving total proceeds at the date of issue of $50 million. The notes pay a coupon of 6% p.a. annually in arrears (payable 30/6). The holder of each note has the option to convert the note into 5,000 ordinary shares of Tierney Ltd at the end of 3 years.

When the notes are issued, the market interest rate for similar debt (similar term, similar credit status of issuer and similar cash flows) without conversion options is 9% p.a.

Required:

Prepare the journal entries for Tierney to record this transaction on:

1) 1 July 2020 when the convertible note is issued

2) 30 June 2021 when the first coupon is payable.

Answer 1

No of Convetible Notes Issued	5,000
Cash received with Issue Price $10,000 per note =	$          50,000,000
Total Annual Coupon @ 6%=	$            3,000,000
Effective Interest Rate without Conversion option =	9%
We shall find the Fair Value of the Liability by discounting the
cash flows by 9%.
PV Annuity factor @9% for 3 years =(1-1.09^-3)/9%=	2.531295
PV Factor @9% for 3 years =1/1.09^3=	0.7721835

PV of Future Cash flows
Cash flows	Amt $	PV Annuity Factor	PV Factor	PV of Cash flows
Annual Interest payment for 3 years	$            3,000,000	2.531295		$      7,593,884.00
Maturity Amount	50,000,000		0.7721835	38,609,174.00
Total PV of Cash flows				$   46,203,058.00

So Total Convetible Note Liability =	$    46,203,058.00
First Year Interest expense @9%=46,203,058*9%=	$      4,158,275.22
Interest Payable @6% on Face value =	$            3,000,000
First Year Credit to Note Liability =	$      1,158,275.22

	Journal Entry
Date	Account Title	Dr $	Cr $
7/1/2020	Cash	50,000,000
	Note Liability		46,203,058
	Share Option (Equity)		3,796,942
	( Issue of convertible note and recognition of Liability and
	Equity portion)
6/30/2021	Interest Expense	4,158,275.22
	Interest Payable		3,000,000.00
	Note Liability		1,158,275.22
	( Recogntion of Interest payable , Interest expense at effective rate on liability
	and credit amount to Note Liability)