Question

Presents highly accurate and appropriately detailed advice on how to account for Convertible Bond at issuance, interest dates, maturity and conversion based on Australian accounting standards.

Answer 1

Convertible bonds are the bonds which entitle the holders to convert bonds into fixed number of shares of the issuing company at the time bond's of maturity. They bear both the characteristics of financial instrument i.e both liability and equity.

At first the liability component is calculated by discounting the future of the bonds at a rate of similardebt instrument without conversion option. The valu of equity component is: Present Value of the liability componentof the convertible bond-proceeds from the issue of bonds.

For eg. A company issues 1 million convertible bonds at 1$ each at ineterest rate of 10% and interest rate of a similar bond without conversion option is 15%. With maturity rate of 3 years and holders are entitled for $1 per share after maturity of bond.

Entry will thus be at the time of issuance:

Cash/Bank A/C Dr. $1,000,000

Liablity Cr. 885839.00(see note below)

Equity Cr.114161 (proceeds)

Present value of future interest payments and principal using 15%

Year 1 $100,000 Interes *1/1.15 = 86956.5

Year 2 $100,000*1/1.15^2 = 75614.4

Year3 100,000*1/1.15^3 =65751.6

Year3 will also have principal:

1,000,000*1/1.15^3=657516.00

All adding upto $885839.00

Interest is charged to the income statement based on the effective interest rate, which is usually higher than the nominal rate, to reflect the true opportunity cost of the financial liability

At the time of Maturity if conversion is not recognised the company will pay the principal amount and so the liability will be derecognised and if the bonds are exercised then:

Liability Dr. 1,000,000

Equity Dr. 114,161

To Share Capital Cr. $ 1,000,000

To Share PremiumCr. $114,161