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August 2023

Split Accounting – How Is A Convertible Instrument Accounted For?

By Dolphy D’souza, Chartered Accountant
Reading Time 10 mins
This article deals with split accounting of a convertible bond into equity and financial liability. The CFO of the entity wants to do the split accounting basis the fair value of the liability and fair value of equity which according to him shall include the probability whether the liability would be settled or not and accordingly derive the value of the financial liability and equity. Would that be acceptable? QUESTION
An entity issues 300,000 convertible bonds at the start of year 1 having three-year tenure, issued at par with a face value of Rs. 100 per bond, resulting in total proceeds of Rs. 30 million. Interest is payable annually in arrears at a nominal annual interest rate of 6 per cent. Each bond is convertible, at any time up to maturity, into 20 ordinary shares (meets the fixed for fixed test). When the bonds are issued, the prevailing market interest rate for similar debt without conversion option is 9 per cent. Since the issue costs are negligible, the same may be ignored. The CFO believes that the chances of the bond being converted to equity are almost 99 per cent. Therefore, keeping in mind the high probability of conversion to equity and extremely low probability that the liability would be settled by cash, the amount attributed to liability should be negligible. Do you agree? How does the entity account for the bond? RESPONSE

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