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Mark Anderson
Mark Anderson, Tax Attorney
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Experience:  Tax attorney and accountant
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I've not worked with convertible notes before. So essentially

Customer Question

I've not worked with convertible notes before. So essentially need to know how to account for them when issued, on a monthly bases, and when the conversion is executed.
Assume a convertible note at 6% simple interest, to be converted at 36 months.
How do I account for them on the Balance sheet before the conversion?
The interest is not payable in cash, but rather will be converted. Do I accrue the interest expense each period?
Should the interest expense be calculated at 6%, or some higher number to account for the value of the convertible feature.
Is the monthly interest accrual considered an operating expense, or part of EBITDA?
Anything else I need to know?
Thanks
Jim
Submitted: 8 months ago.
Category: Tax
Expert:  Mark Anderson replied 8 months ago.
Here is a link that shows you how to account for it:http://accounting-simplified.com/financial-accounting/articles/example-of-accounting-for-convertible-bonds.htmlI hope this answers your question. If not, then please reply. Thank you.
Customer: replied 8 months ago.
Thanks Mark.What I don't see in the article are:
1) How to determine what the interest rate on a 6% note would be without the convertible option.
2) Is the interest expense considered an operating expense? Or Interest under EBITDA. What I've read says that is should be under EBITDA like any other interest expense. Just need to verify is that's correct.Thanks
Jim
Expert:  Mark Anderson replied 8 months ago.
I would think it would be the rate of a similar bond:Interest rate of a similar bond without the conversion option is 15%. - See more at: http://accounting-simplified.com/financial-accounting/articles/example-of-accounting-for-convertible-bonds.html#sthash.bCq9nmZf.dpufYes. It would be charged like other interest:http://accounting-simplified.com/financial-accounting/articles/accounting-for-convertible-bonds.htmlDo you have an accountant for your company? I would run it buy them.
Customer: replied 8 months ago.
ThanksThe example is based on a note that is 10% with the conversion option, and puts it at 15% without the option. The actual notes we are using are 6% with the conversion. So I'm assuming maybe 10% without. I don't know if there is any official guidance on how to determine the the equivalent rate without conversion.Yes, we have an accounting firm, but they don't have experience with convertibles notes either. If you mean by " It would be charged like other interest" that like other interest it would be under EBITDA, that makes a world of difference, since the investors are only interested in EBITDA at this point.Thanks
Jim
Expert:  Mark Anderson replied 8 months ago.
You can read the FASBs:http://www.fasb.org/cs/BlobServer?blobkey=id&blobnocache=true&blobwhere=1175820914293&blobheader=application/pdf&blobcol=urldata&blobtable=MungoBlobs
Expert:  Mark Anderson replied 8 months ago.
Is it based upon market price? Here is some info and valuation:http://www.sec.gov/answers/convertibles.htm
Expert:  Mark Anderson replied 8 months ago.
http://us.allianzgi.com/MarketingPrograms/External%20Documents/Understanding_Convertibles_IES_016.pdf
Expert:  Mark Anderson replied 8 months ago.
This says EPS increases:http://www.investopedia.com/university/financialstatements/financialstatements8.asp
Expert:  Mark Anderson replied 8 months ago.
That does stand for Earning Before Interest.
Expert:  Mark Anderson replied 8 months ago.
Here is some more info:http://www.pwc.com/us/en/audit-assurance-services/accounting-advisory/convertible-securities.html
Expert:  Mark Anderson replied 8 months ago.
http://www.pwc.com/us/en/cfodirect/assets/pdf/in-depth/us2016-01-fasb-financial-instruments-recognition-measurement.pdf
Expert:  Mark Anderson replied 8 months ago.
http://smallbusiness.chron.com/convertible-bonds-affect-balance-sheet-72089.html

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