ABC LTD issues 1 million convertible bonds of $1 each carrying nominal interest of 10%. Bondholders are entitled to convert their bonds into $1 ordinary shares of the company on the date of their maturity in three years time instead of receiving principle repayment.
Interest rate of a similar bond without the conversion option is 15%.
How must ABC LTD account for the convertible bonds upon initial recognition, subsequent measurement and maturity assuming all bonds are converted after three years?
Initial Recognition
Following accounting entries must be recorded upon initial recognition:
|
Debit |
Cash/Bank |
$1,000,000 (Total Proceeds) |
|
Credit |
Liability |
$885,839 (Note 1) |
|
Credit |
Share Options (Equity) |
$114,161 (Balancing Figure) |
Note 1:
Present value of future interest payments and principal using 15%:
|
Year 1 |
$100,000 (interest) |
x |
[1/1.15] |
= |
$ 86,956.5 |
|
Year 2 |
$100,000 (interest) |
x |
[1/1.15^2] |
= |
$ 75,614.4 |
|
Year 3 |
$100,000 (interest) |
x |
[1/1.15^3] |
= |
$ 65,751.6 |
|
Year 3 |
$1,000,000 (principal) |
x |
[1/1.15^3] |
= |
$ 657,516.0 |
|
Total |
$ 885,839.0 |
||||
Subsequent Measurement
Interest expense will be charged using 15%. The difference between interest paid and interest charged will be added to the liability component as follows:
| Interest Expense | $ | Liability | $ | |
|---|---|---|---|---|
|
Year 1 |
[885,839 x 15%] |
132,876 |
[885,839 + 132,876 - 100,000*] |
918,715 |
|
Year 2 |
[918,715x 15%] |
137,807 |
[918,715+ 137,807 - 100,000] |
956,522 |
|
Year 3 |
[956,522x 15%] |
143,478 |
[956,522+ 143,478 - 100,000] |
1,000,000 |
*$100,000 is the 10% nominal interest.
Maturity
Following accounting entry will be required to account for the conversion of bonds into shares after three years:
|
Debit |
Liability |
$1,000,000 |
|
Debit |
Share Options (equity) |
$114,161 |
|
Credit |
Share Capital |
$1,000,000 |
|
Credit |
Share Premium |
$114,161 |