On 1 October 2013 Bolgatanga Ltd issued $10 million 6% convertible loan stock on the following terms:

The issue price was at par.

The loan stock is convertible into the company’s equity shares at the option of the stockholders four years after the date of its issue (30 September 2017) on the basis of 20 shares for each $100 of loan stock.  Alternatively, it will be redeemed at par.

Lagos Services had advised that if Bolgatanga Ltd had issued similar loan stock without the conversion rights, then it would have had to pay an interest (coupon) rate of 10% on the loan stock.  This is because the terms of conversion to equity shares are favourable.

Lagos Services further advised that because it is almost certain that the loan stock holders will exercise their right to convert to equity shares, the loan stock has the substance of equity and can be included as such on the statement of financial position. This has the added advantage of improving/reducing the company’s gearing (debt/equity) in comparison to what would be the case with the issue of ‘straight’ loan stock.


The present value of $1 receivable at the end of each year, based on discount rates of 6% and 10% can be taken as:

Year Discount factor @ 6% Discount factor @ 10%
1 0.94 0.91
2 0.89 0.83
3 0.84 0.75
4 0.79 0.68



In relation to the 6% convertible loan stock, calculate the finance cost to be shown in the statement of profit or loss and the extracts from the statement of financial position for the year to 30 September 2014; and comment on Lagos Services’ advice.






IAS 32 Financial Instruments: Disclosure and Presentation says that the issuer of a compound (hybrid) instrument (i.e., one that contains both a liability debt and an equity element) should classify the instrument’s components separately.  Thus, the advice of Lagos Services is wrong; convertible loan stock cannot be classified as pure equity.  The proceeds of the issue have to be split between the amount attributable to the conversion rights, which is then classed as equity, and the balance of the proceeds being classed as liability/debt.  There are several methods of obtaining these amounts, but from the information given in the question, these can only be calculated on a ‘residual value of equity’ basis.

THE BIG QUESTION: How do we split the Convertible loan note into debt and equity?

To answer that question, we follow three basic steps:

Initial recognition

Step 1: Calculate the Debt Component – this is calculated by discounting the cash flow on the loan notes using the interest rate of similar debts without conversion right. In this question, its 10%.

Step 2: Calculate the Equity Component – this is calculated by deducting the Debt Component obtain in step1 from the total proceeds from the issue of the Convertible loan notes.

Step 3: Treatment of issue cost – when the entity incurs issue costs, then it is allocated on a proportionate basis to both the debt and equity using the figures obtained in steps 1 & 2

                                                                                                                    Cash              Factor        at Present

flows             10%                   value

      $000       $000
Year 1 interest 600 0.91       546
Year 2 interest 600 0.83      498
Year 3 interest 600 0.75      450
Year 4 interest and capital








Total value of debt component       8,702
Proceeds of the issue








Equity component (residual amount)








Subsequent measurement:


Debt component: The debt component is carried amortised cost (value in step 3) taking into consideration the effective interest rate or interest rates on similar bonds.

The interest (at effective rate) is recognized in the Statement of Profit or Loss while the carrying forward amount is recognized in the Statement of Financial Position under Non–Current Liabilities.


Equity component: The equity (value in step 3) is carried at that initially recognized value in the Statement of Financial Position under Equity and Reserves until the date of conversion, where the treatment is based on whether the loan note is converted into equity shares or redeemed.


Amortised cost schedule


Year balance b/f Interest @10% Payment @6% Balance c/f
1 8702 870.2 (600) 8972.2


Statement of profit or loss for the year to 30 September 2014

Finance cost                                                                                   870,200


Statement of financial position as at 30 September 2014

Non-current liabilities:  
6% Convertible Loan Stock (from above) 8,702,200


Capital and reserves:  
Option to convert to equity (from above) 1,298,000