Hi All,
May i get your opinion on the below as i am confused on the recognition:
A company issued a total of USD5 million convertible promissory note and it bears interest of 5% p.a. until the end of 5 years’ time (maturity period). However, there will be an automatic conversion should Qualified Financing happen during the 5 year period or Optional Conversion should non-qualified financing happen during the 5 year period. The conversion will be an amount equal to lower of 90% of the lowest pre-share selling price.
1. Should this convertible promissory note accounted as compound instrument or financial liability? As there's mandatory conversion and also optional conversion.
2. If this is a debt instrument, will it be a FVPL?
Many Thanks!
Convertible Promissory Note
Re: Convertible Promissory Note
You are recognising it as a holder I guess, in that case, not expected to satisfy the SPPI criteria because even though it can be converted into a variable number of shares, it seems that there is a cap "90% of the lowest [...]".
FVPL
FVPL
Re: Convertible Promissory Note
Leo, read question 1 again please. Do holders recognise financial liabilities when accounting for their non-derivative investments?
Re: Convertible Promissory Note
From an issuer's perspective, I think:
1. Cash payment of interest and principal: May need to know what the qualified and non qualified terms are, whether they are as the holders' discretion or the issuer can trigger some clauses that make them giving shares instead of paying cash back. If there is a contractual obligation to pay cash the the issuer cannot avoid, it would be a liability.
2. Conversion feature to convert the amount into XXX (variable) number of shrares: This feature looks like a derivative liability to me.
Looks like a hybrid financial liability, i.e., Liability combined with a derivative liability.
For the accounting, I'd say, initially assessed separately and accounted separately. The fair value of the derivative should be assessed first and the value is the residual amount. Subsequently, debt carried at amortised cost and derivative at fair value.
However, there may be an option to account the whole instrument at fair value. avoiding the complications.
1. Cash payment of interest and principal: May need to know what the qualified and non qualified terms are, whether they are as the holders' discretion or the issuer can trigger some clauses that make them giving shares instead of paying cash back. If there is a contractual obligation to pay cash the the issuer cannot avoid, it would be a liability.
2. Conversion feature to convert the amount into XXX (variable) number of shrares: This feature looks like a derivative liability to me.
Looks like a hybrid financial liability, i.e., Liability combined with a derivative liability.
For the accounting, I'd say, initially assessed separately and accounted separately. The fair value of the derivative should be assessed first and the value is the residual amount. Subsequently, debt carried at amortised cost and derivative at fair value.
However, there may be an option to account the whole instrument at fair value. avoiding the complications.
Re: Convertible Promissory Note
The qualified financing is the issuance of preference shares more than x amount initiated by the issuer, not at holder's discretion.
Re: Convertible Promissory Note
If the holder ask the issuer to deliver cash and the issuer can't refuse to do so, then, it's a liability.
However, where I don't know, which is my question to all the experts here, is if there is conditions in the contract whereby the issuer can do to avoid paying cash.
For example, a clause where "issuance of preference shares more than x amount", so the issuer can issue more than X amount for the conversion right to be triggered automatically. In that case, is the liability still considered as a liability?
However, where I don't know, which is my question to all the experts here, is if there is conditions in the contract whereby the issuer can do to avoid paying cash.
For example, a clause where "issuance of preference shares more than x amount", so the issuer can issue more than X amount for the conversion right to be triggered automatically. In that case, is the liability still considered as a liability?
Re: Convertible Promissory Note
Continue on the above post, a very straight forward convertible note: Issuer issue a convertible note and the holder has the option to received cash for convert into shares at the maturity.
So, this would be treated as a liability for the payment of principal and interest and derivatives liability or equity for the conversion feature.
Now, the same, but with a clause saying "If the issuer do XXX (this or that), then, the conversion will automatically be converted into a fixed amount of shares for XXX value each.
Is this still treated as a liability? I would say it's a Equity here because the issuer can purposely do XXX, to trigger the conversion into a fixed amount of shares.
Do you agree?
And if yes, is that an equity + a derivative for the conversion feature or just Equity?
So, this would be treated as a liability for the payment of principal and interest and derivatives liability or equity for the conversion feature.
Now, the same, but with a clause saying "If the issuer do XXX (this or that), then, the conversion will automatically be converted into a fixed amount of shares for XXX value each.
Is this still treated as a liability? I would say it's a Equity here because the issuer can purposely do XXX, to trigger the conversion into a fixed amount of shares.
Do you agree?
And if yes, is that an equity + a derivative for the conversion feature or just Equity?
Re: Convertible Promissory Note
Hi TaroSushi,
My opinion:
1. This is a compound instrument. Interest payments cannot be avoided and shall be treated as a liability. The Qualified Financing trigger is only accelerating the timing of conversion. This conversion feature shall be treated as equity.
2. The financial liability and equity components shall be presented separately on the balance sheet. The financial liability component shall be carried at amortised cost. The equity component shall be carried at the value determined as at the date of recognition.
My opinion:
1. This is a compound instrument. Interest payments cannot be avoided and shall be treated as a liability. The Qualified Financing trigger is only accelerating the timing of conversion. This conversion feature shall be treated as equity.
2. The financial liability and equity components shall be presented separately on the balance sheet. The financial liability component shall be carried at amortised cost. The equity component shall be carried at the value determined as at the date of recognition.