Sompa Ltd issued a GHC40 million 15% convertible loan note at par on 1 January 2010 with interest payable annually in arrears. Three years later, on 31 December 2012, the loan note is convertible into equity shares on the basis of GHC100 of loan note for 50 equity shares or it may be redeemed at par in cash at the option of the loan note holder. The company's financial accountant observed that the use of a convertible loan note was preferable to a non-convertible loan note as the latter would have required an interest rate of 20% in order to make it attractive to investors.

The accountant has also commented that the use of a convertible loan note will improve the profit as a result of lower interest costs and, as it is likely that the loan note holders will choose the equity option, the loan note can be classified as equity which will improve the company's high gearing position.

Required:

i) Discuss the validity or otherwise of the Financial accountant's comment

ii) Show how the convertible loan note should be accounted for in Sompa Ltd's income statement for the year ended 31 December 2010 and statement of financial position as at 31 December 2010

Answer rating: 100% (QA)

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