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The following guidance covers Old UK GAAP (applied before 2015) where FRS 26 was not applied.

Accounting for convertible securities

A convertible security is a loan that may be converted into another asset. The conversion can be at the option of the lender or the borrower and the terms of conversion can vary considerably. As a convertible security is a loan and a right to convert combined, the accounting for it follows the two component parts.

Example 1

Lampon plc makes a 拢100m loan to Sparty Ltd bearing interest at 8% fixed. The loan can either be repaid (redeemed) or at the option of the lender the loan can be converted into 10,000,000 ordinary shares of Sparty Ltd. The option can be exercised at any point after 5 years. Lampon plc accounts for the convertible as a 拢100m 8% fixed rate loan, and the income receivable as interest in the profit and loss account. If the lender exercises the right to convert then the loan is reclassified as an investment in shares with no change to its book value. The bookkeeping in Lampon plc upon conversion would be:

-	Debit	Credit
Investment in Sparty Ltd	拢100 million	-
Loan to Sparty Ltd	-	拢100 million

Example 2

Lampon plc makes a 拢100m loan to Minnie plc bearing interest at LIBOR plus 2%. The loan can either be redeemed or at the option of the lender the loan can be converted at the 5 year point into ordinary shares in Minnie plc with a market value of 拢110m. Lampon plc accounts for the convertible as though it was a loan for 拢100m bearing variable interest of LIBOR plus 2% with a premium on conversion of 拢10m after 5 years. Thus by the end of year 5, the carrying value of the loan in Lampon plc鈥檚 balance sheet will be 拢110M.

This example differs from example 1 because Lampon plc acquires shares in Minnie plc with a stated market value (拢110M) and not as is example 1 a set number of shares. Furthermore, because the market value of the shares which Lampon plc will receive (拢110M) exceeds the amount it would receive should the loan be redeemed (拢100M) it has been assumed that the option to convert will be exercised.

Example 3

Lampon plc makes a 拢100m interest free loan to Ziggy plc. After 5 years the borrower can either redeem the loan at 拢120m or issue 10,000,000 ordinary shares in Ziggy plc. Lampon plc accounts for the convertible as though it was a zero coupon bond with a premium of 拢20m after 5 years. If the share price of Ziggy plc falls below 拢12 then the recoverability of the 拢120m at redemption should be assessed as it is likely that the borrower will exercise the option to convert the loan to shares instead of redeeming it.