Equity component of convertible loan upon settlement.

[JRSB]

An entity issues 50,000 convertible bonds of total 50,000 face value and determines that there is an equity component, so say €30,000 treated as liability, and €20,000 as equity in its own books on day 1, Per IAS 32.

A conversion event then takes place, so that the bond is extinguished mandatorily by the issue of 100,000 shares because there is a formula of 2 shares per face value of bonds. This infers an issue price of €2 per bond.

So there is €50,000 to show as new shares issued in equity and the liability becomes zero.

Does the €20,000 equity element which was recorded on issue of the bonds stay there for ever more, or is it released in some way? IAS 32 seems silent on eventual treatment of the equity component.

[Ketan Marwah]

Hi JRSB,

I wouldn’t expect it to go anywhere (refer IAS 32.AG32) as that is the value allocated to the embedded option on initial recognition even when the option is out of the money (IAS 32.AG31(b)). So it sits handsomely where you left it at the beginning with the flexibility of it being okay to be moved around still within equity:-).

[JRSB]

Great reference Ketan!

[Porus]

What would be the accounting entry upon extinguishment ?
Dr. Convertible Loan 30,000
Dr. ??????????
Cr. Share capital 50,000

There is already 20,000 sitting in equity since Day 1.

Or would we pass the following entry ?
Dr. Convertible Loan 30,000
Cr. Share capital 30,000

And then move the 20,000 also to share capital from the separate component of equity where it was lying since Day 1 ?

[Ketan Marwah]

Hi Porus,

I don't think that IFRS specifies classification within equity so the debit posting could be made basis the local company law like for instance I have seen companies use APIC (additional paid in capital) OR Share Premium OR Retained Earnings depending on where are they based exactly and the difference between issued share capital and share proceeds. Share capital denotes the share structure of the entity so I would bear that in mind when deciding on the debits and credits (& obviously local law too).

[Porus]

Just realised that the missing debit would be partly or wholly covered over a period of time since inception of the convertible loans, by way of unwinding of the interest, under the effective interest rate method. So the loan balance at the date of the conversion event would be higher than 30,000. It might well be back to 50,000, or somewhere between 30,000 and 50,000 on the date of conversion event.

Two scenarios:
1) Let's say the convertible loan is back to 50,000 after unwinding, on conversion date. In which case the entry, in my view, would be:
Dr. Convertible Loan 50,000
Cr. Share capital 50,000
And the 20,000 sitting in equity since Day 1 would move to APIC.

2) Convertible loan stands at 40,000 after unwinding, on conversion date. In which case the entry, in my view, would be:
Dr. Convertible Loan 40,000
Dr. P&L (loss on extinguishment of liability) 10,000
Cr. Share capital 50,000
The 20,000 sitting in equity since Day 1 would move to APIC, as above.

Does that make sense ?

[Ketan Marwah]

Hi Porus,

Please read this section because the answer depends on whether the conversion takes place upon maturity or not. This thread was about conversion but since you have mentioned extinguishment, I am unsure if you want to link the topic to debt for equity swaps. Anyhow the below link would guide you through both the cases.

https://ifrscommunity.com/knowledge-bas ... instrument

[Porus]

Thanks Ketan. No not debt-for-equity swaps, I was referring only to conversion happening on the occurrence of a conversion event before maturity. So, it would appear that, in scenario 2 above, assuming the fair value of the liability component was the same as the carrying amount, nothing would go to P&L, and the difference of 10,000 would go to equity ?

Dr. Convertible Loan 40,000
Dr. Equity 10,000
Cr. Share capital 50,000
The 20,000 sitting in equity since Day 1 would move to APIC, as above.

[Ketan Marwah]

The 20,000 sitting in equity since Day 1 would move to APIC, as above.

Hi Porus,

As mentioned in one of my earlier posts that IAS 32 does not specify classification within equity. It has to be in sync with the local law so I wouldn't be able to confirm your account selection besides that you are thinking in the right direction with your debits/credits & there wouldn't be a gain/loss from conversion. Also, the original equity component remains as equity although it may be transferred from one line item within equity to another (IAS 32.AG32).

I hope we can retire the thread now with this agreement + confirmation

[Porus]

Yep

[Marek Muc]

Locking it just in case