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Hi, I have come across a question with both loan note and convertible loan note elements. Could you please advise how this would be worked through and how would be input into the SOFP and IS.
Convertible loan note issued on 1 Jan 14 at its par value. Direct issue costs of £5million were charged to operating expenses. Loan note is redeemable on 31 Dec 2017 at a premium of 10% to compensate for the interest rate of 2% although there is an option to convert the loan into equity shares on, but not before, the redemption date on the basis of 50 equity shares per £100 loan note. The effective rate of interest on the loan note is 8% per annum. The trial balance shows the convertible loan note as £150 million (2%).
This question seems to be a mixture of the typical loan note / convertible loan note questions from past papers and I don’t know how to combine the 2, any help appreciated thanks
I think that the loan note in sentence 3 is probably the same convertible loan note that has the conversion right.
Is there a second loan note in the trial balance? I imagine not. In that case, there’s only one loan note of $150 with an interest rate of 2% redeemable at a premium of 10% or convertible into equity
If there’s only one loan note in the trial balance, then there’s only one loan note!
What does the answer show?
I hope it’s only one loan!
Sorry, yes there is only one convertible loan, I was getting confused. Could you advise how to work through the question please, if you ignore my other nonsense and this is just the question.
Convertible loan note issued on 1 Jan 14 at its par value. Direct issue costs of £5million were charged to operating expenses. Loan note is redeemable on 31 Dec 2017 at a premium of 10% to compensate for the interest rate of 2% although there is an option to convert the loan into equity shares on, but not before, the redemption date on the basis of 50 equity shares per £100 loan note. The effective rate of interest on the loan note is 8% per annum. The trial balance shows the convertible loan note as £150 million (2%).
Many thanks in advance
My initial workings was to take the direct issue costs out of the P&L and deduct these from the loan amount to make this £145million.
On the trial balance it shows an interest payment of £3000 (150million*2%) , however with the new amount of !45 million I assumed the interest would now be £2900, obviously we have credited the bank £3000 and I want to debit £2900 to the P&L , where does the remaining £100 get debited, am I on the right lines with the interest payment?
No, you’ve wandered off! You are correct to deduct $5m from operating expenses and debit that amount instead to the face value of the loan bringing that disclosed obligation down to $145m
But the loan note is for $150 and that’s the basis for the 2% interest calculation giving an amount paid correctly shown as $3m
What we need to do with a mixed instrument like this is calculate the present value of the obligation and compare that with the face value of the loan note. The missing amount (difference between present value and face value) is therefore the equity element
The present value of the cash payable in respect of the loan is $3m interest in 2014, 15, 16 and 17 + $165m in 2017
Calculate the present values of those 4 payments using an 8% discount rate and arrive at a value of $131,216,306 and that’s the value of the obligation as at day 1, 1st January, 2014
In another table with 4 columns (brought forward, effective interest at 8%, -interest payable (3,000), carried forward) calculate the schedule of interest for the statement of profit or loss and the balance on the obligation account for the statement of financial position
If you do that correctly you’ll arrive at an amount at the end of 2017 of $164,999,999.99 according to my calculations and that represents $150m redeemable at a premium of 10% in 4 years’ time
Is that any better?
amount discount present
payable factor value3,000.0000 0.925925926 2,777.7778
3,000.0000 0.85733882 2,572.0165
3,000.0000 0.793832241 2,381.4967
168,000.0000 0.735029853 123,485.0153131,216.3062
brought effective amount carried
forward interest 8% paid 2% forward
131,216,306.2000 10,497,304.4960 3,000,000.0000 138,713,610.696
138,713,610.6960 11,097,088.8557 3,000,000.0000 146,810,699.552
146,810,699.5517 11,744,855.9641 3,000,000.0000 155,555,555.516
155,555,555.5158 12,444,444.4413 3,000,000.0000 164,999,999.957Oh, and if $131,216,306.2 is the loan element, then 150,000,000 – 131,216,306 ie 18,783,694 is the equity element and is shown in “Other components of equity”
Thankyou that makes everything a lot clearer , so basically once the $5 million direct issue costs are removed from the p&l , they then have no further inclusion with any of the workings ?
So for year end 2014 the entries in the accounts would be:
Cr Debt component $131,216,306
Cr Equity component $18,783,694
Dr finance cost £3m
Dr bank $147m ?Ohh no , initial recognition would be
Cr debt 131,216,306
Cr equity option 18,783,694
Dr bank 150mAnd then for year 1 it would be
Dr finance cost 10497304 (131,216,306*8%)
Carrying amount of loan on sofp (131,216,306 + 10,497,304 – 3,000,000)
$138,713,610So all that would show on my year end accounts would be the finance cost for the year of $10,497,304 which would also reduce the 150m Dr to the bank.
My carrying amount in liabilities of $138,713,610
And my equity option would stay the same ?
Equity will stay the same
$3m cash paid for interest will be debited to finance charges
$7,497,304 will debit finance charges and credit loan account
$150m will debit cash, credit loan account $131,216,306, credit equity $18,783,694
Ok?
Yes thankyou what are the entries for the 5m issue costs , are they just credited out of the p&l because the 145m just disappears after the first working ?
Hi
I wonder if you can help me, I’m very confused on the above.
In your response you said the $5m is deducted to give the loan note a recognised value of $145m but the face value of $150m is used to calculate annual finance cost at 2%.
However in June 2010 Q2 (Dune) the solution shows the loan note (face value $20m) being reduced by the direct costs of $500k and then this amount being used at the effective financing rate of 10% (19500 @ 10% = 1950). Why on earth is this different?!
Many thanks for any help you could provide
But $19.5 is not used to calculate the interest that is paid! It’s used to calculate the effective interest that is accruing, but not the interest actually paid. The lender doesn’t care how you treat the costs of obtaining the loan. All the lender is interested in is getting their 10% on $20 million
Sorry, I must be missing something huge in this. If you use 10% on 20 million in Dune you would be wrong according to the Acca solution
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