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On 1 april 20×3 xtol issued a 5% $50 million convertible loan note at par. Interest is payable annually in arrears on 31 march each year. the loan note is redeemable at par or convertible into equity shares at the option of the loan note holders on 31 march 20×6. the interest on an equivalent loan note without the conversion rights would be 8% per annum.
the present values of $1 receivable at the end of each yea, based on discount rates of 5% and 8%, are:
5% 8%
end of year 1 0.95 0.95
2 0.91 0.86
3 0.86 0.79how do we treat this in financial statements?
Point number 1 – the 8% discount factor for year 1 that you have give me is 0.93 and NOT 0.95
Have you watched any of the revision lectures where I work through similar exercises?
Have you read through the notes on financial instruments where there is an example of how to tackle this problem?
:-(((
We need to calculate how much of this mixed instrument relates to debt and how much relates to equity
To do this we need to find the present value of the amounts payable to service the $50,000,000 loan
Set up a 4 x 4 table
Row 1 is the headings:
“Year” “Amount” “Discount factor” “Present value”
Note – I’m going to use the accurate discount factors but you will only be given, and only expected to use, discount factors to 2 decimal places
Row 2 put in:
“1” “2,500” “.925926” “2,314,815”
Row 3 put in:
“2” “2,500” “.857339” “2,143,347”
Row 4 put in:
“3” “52,500” “.793832” “41,676,193”
Add those present values together and arrive at $46,134,355
That’s the present value of the debt obligation and therefore the equity element (shown separately in the equity section of the statement of financial position) must be $50,000,000 – $46,134,355 = $3,865,645
So, the loan obligation is $46,134,355
Now we can work out the finance charge involved in servicing this debt
Set up a 4 x 4 table
Row 1 is the headings:
“B/fwd” “True interest at 8%” “(Interest paid at 5%)” “C/fwd”
Row 2 put in:
“46,134,355” “3,690,748” “(2,500,000)” “47,325,103”
Row 3 put in:
“47,325,103” “3,786,008” “(2,500,000)” “48,611,111”
Row 4 put in:
“48,611,111” “3,888,889” “(2,500,000)” “50,000,000”
(If you use the two decimal places discount factors that are given to you, this last figure of $50,000,000 comes to $49,768,000)
The difference between column 2 “true interest” and column 3 “interest paid” is the additional amount of interest that will give rise each year to the double entry …
Dr Finance charges on the statement of profit or loss
Cr Debt Obligation Account on the statement of financial positionOK?
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