CFM23090 - Accounting for corporate finance: UK GAAP before 1 January 2005: borrowers: accrual accounting: convertibles: examples

Accounting for convertible securities

Example 1

Snowy plc issues a £100m loan bearing interest at 8% fixed. At the option of the lender the loan can be converted into 10,000,000 ordinary shares of Snowy plc at any point after 5 years. This is a convertible and Snowy plc accounts for it as a £100m 8% fixed rate loan. If the lender exercises the right to convert then the outstanding £100m loan is removed from creditors in the balance sheet and is taken to share capital (nominal value of shares) and share premium account.

Example 2

Wolfa plc issues a £100m loan bearing interest at LIBOR plus 2%. At the option of the lender the loan can be converted at the 5 year point into ordinary shares in Wolfa plc with a market value of £110m. Wolfa plc accounts for the convertible as though it was a loan for £100m bearing variable interest of LIBOR plus 2%. When the debt is converted to shares, the shares are recorded at £100m and thus no gain or loss is recognised on conversion.

Example 3

Attila Ltd issues a £100m loan interest free. After 5 years the loan will either be redeemed at £120m cash or the lender has the option of converting the debt into 10,000,000 ordinary shares in Attila Ltd.

Attila Ltd accounts for the convertible as though it were a zero coupon bond. It accrues the £20m premium over the five years. The value of the debt has been capped at £120m as the lender has the right to the share issue rather than cash redemption of the bond and will clearly take this route if the share price rises above £12.

If the lender exercises its right to convert and the shares are issued, Attila Ltd will record the shares at £120m.