Question

TREATMENT OF CONVERTIBLE DEBENTURES
LS Limited issued 1 million six-year debentures on 1 January 2018 at par value of £ 100 each at a fixed rate of 6% per annum. Interest payable at the end of each year whereas the principal is to be repaid in two equal installments at the end of 2022 and 2023.



Debentures were issued with an option to convert 10 debentures into 4 ordinary shares of LS Limited till the date of first principal redemption. The liability was not designated as measured at fair value through profit or loss on initial recognition.



The market interest rate for non-convertible debentures issued by entities having similar credit risk and loan tenor is 1-Year LIBOR + 2% per annum.


On 1 January 2019 LS Limited repurchased 100,000 debentures at a premium of £ 5 per debenture. Transaction cost of £ 2 per debenture was incurred on this redemption.


The market interest rates and market values of LS Limited's shares are given below:

Date 1-YEAR LIBOR Market value per share
1 January 2019 5% 200
1 January 2020 6% 250

Required:

Prepare Journal Entries in the books of LS Limited for the year ended 31 2019

Answer 1

The debenture issued contains 2 component-

1. Liability component for the debenture payable

2.Equity component for the conversion option.

Liability component will be recorded initially at the Fair value by discounting the the Cash outflows at effective interest rate.

Here the effective interest rate is 7% per annum.

In layman term we can say that the company instead of paying 7% interest , is now paying 6% interest with a conversion option given to the debenture holder.

Calculating FV of the liability or PV of future cash flow-

Date	cashflows(Interest)	Cash flows(Principal)	Total cash flow	PVF@7%	pv of cash flow
31-12-2018	6000000	0	6000000	0.9346	5607477
31-12-2019	6000000	0	6000000	0.8734	5240632
31-12-2020	6000000	0	6000000	0.8163	4897787
31-12-2021	6000000	0	6000000	0.7629	4577371
31-12-2022	6000000	50000000	56000000	0.7130	39927226
31-12-2023	3000000	50000000	53000000	0.6663	35316138
				Total	95566631

* Interest per annum(Upto 31-12-2022)	1000000*100*6% =6000000
** Interest in 2023	1000000*100*1/2*6% =3000000

Subsequent measurement of the Liability-

Year	Opening balance	interest exoenses@7%	amount paid	closing balance
2018	95566631	6689664	6000000	96256296
2019	96256296	6737941	6000000	96994236
2020	96994236	6789597	6000000	97783833
2021	97783833	6844868	6000000	98628701
2022	98628701	6904009	56000000	49532710
2023	49532710	3467290	53000000	0

Journal entry for the year ended 31-12-2018

Date	Accounts	Debit	Credit
01-01-2018	Cash	100000000		(1000000*100)
	Liability		95566631
	Share options(Equity)		4433369	(Balancing figure)
	(Initial record of liability and equity)
31-12-2018	Interest Exenses	6689664
	Liability		6689664
	(to record interest expenses)
31-12-2018	Liability	6000000
	Cash		6000000
	(Payment towards liability)

Journal entry for the year ended 31-12-2019

Date	Accounts	Debit	Credit
01-01-2019	Liability	12830649
	Cash		10700000	(100000*107)
	Share options(Equity)		2130649
31-12-2019	Interest Exenses	6674052		83425647*8%
	Liability		6674052
	(to record interest expenses)
31-12-2019	Liability	5400000		(900000*100*6%)
	Cash		5400000
	(Payment towards liability)

Working-

Date	cashflows(Interest)	Cash flows(Principal)	Total cash flow	PVF@8%	pv of cash flow	PVF@6%	Pv OF CASH FLOW@6%
31-12-2019	5400000	0	5400000	0.9259	5000000	0.943	5094340
31-12-2020	5400000	0	5400000	0.8573	4629630	0.890	4805981
31-12-2021	5400000	0	5400000	0.7938	4286694	0.840	4533944
31-12-2022	5400000	45000000	50400000	0.7350	37045505	0.792	39921521
31-12-2023	2700000	45000000	47700000	0.6806	32463818	0.747	35644215
				Total	83425647		90000000

* Interest per annum(Upto 31-12-2022)	900000*100*6% =5400000
** Interest in 2023	900000*100*1/2*6%=2700000

As on 1-1-2019	Original	Revised	Change
Liability	96256296	83425647	12830649