# Accounting for Convertible Bonds Illustration – Example

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