CFM23080 - Accounting for corporate finance: UK GAAP before 1 January 2005: borrowers: accrual accounting: convertibles

Accounting for convertible securities

A convertible security is a loan that may be converted into another asset. The conversion can be at the option of the lender or the borrower and the terms of conversion can vary considerably.

FRS 4 governs the accounting treatment of convertibles. FRS 4 states that a convertible debt should be accounted for without anticipating conversion, therefore it is treated as a liability. The finance costs are also charged on the assumption that the debt will never be converted, right up to the conversion date. If and when it is converted the amount at which the liability is recorded in the balance sheet, including any accrued discount or premium, should be taken to shareholders funds; nominal value of the shares to share capital and any excess over nominal value to the share premium account. No gain or loss on conversion should be recognised on conversion.

Debt for equity

Where a debt is converted into shares because the borrower is unable to repay, this is not a true convertible, it is part of a reconstruction. Such a transaction may involve the release of part of the debt and the conversion of the remaining amount. In these circumstances the issue of shares will be reflected in the share and share premium accounts and the amount relating to the release of the liability will be reflected in the profit and loss account.

For examples of the appropriate accounting treatment see CFM23090.