Convertible Bonds Flashcards
What is a convertible bond?
Convertible Bonds entitle bondholders to convert their bonds into a fixed number of shares of the issuing company usually at the time of their maturity. Convertible bonds are a type of compound financial instrument with characteristics of both liability and equity.
IFRS propose that the issuing company must separately identify the liability and equity components of convertible bonds and treat them accordingly in the financial statements.
How do we initially recognise a convertible bond in the financial statements
Initially, the liability component is calculated by discounting the future cash flows of the bonds (interest and principle) at the rate of a similar debt instrument without the conversion option.
The value of the equity component is the difference between the present value of the liability component of the convertible bond (as mentioned above) and the total proceeds from the issue of bonds.
This is known as the residual approach to calculation of equity component which assumes that value of the share option is equal to the difference between the total issue proceeds of the convertible bonds and the present value of future cash flows using the interest rate of a similar debt instrument without the option to convert into shares
How do we subsequently treat convertible bonds in the accounts?
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.
Provision carried forward X interest rate for a bond without the equity option
