Will your convertible notes become a current liability?

Kristen Haines

13 March 2024

The use of convertible notes in debt fundraising activities may be impacted by changes in the financial reporting definition of current versus non-current liabilities. This amendment may result in more debt being classified as current, including those convertible instruments that are convertible at any time at a discount to the current market share price.

This could have a significant impact on the perceived financial stability of start-ups or debt laden companies who are using convertible debt. Therefore, the features of convertible instruments should be carefully considered when raising new debt.

Currently, any conversion feature in a convertible instrument has been ignored in determining whether to classify the underlying debt as current or non-current. However, this will no longer be the case for years beginning on or after 1 January 2024. This may result in what a business considers to be a long-term convertible debt having to be classified as current on the statement of financial position. The new rule will apply to all convertible instruments that are considered to be primarily debt in nature and are often referred to as convertible notes or, preference shares amongst other terms.

The amendments

The amendments to AASB 101 Presentation of Financial Statements relating to the current/ non-current classification of liabilities considers the issuance of equity instruments to extinguish a liability to be settlement of that debt. Accordingly the terms of the conversion feature will impact the current/ non-current classification of the debt, unless the conversion feature is classified as equity in accordance with AASB 132 Financial Instruments: Presentation.

When a debt has a conversion feature included in it, the principles of AASB 132 require an entity to determine whether it is considered a liability classified conversion feature or an equity classified conversion feature. Conversion features are considered to be equity classified when they meet the ‘fixed-for-fixed’ requirement. That is where a fixed amount of cash (or other consideration) is exchanged for a fixed number of equity instruments. If the conversion fails the fixed-for-fixed test, then the conversion feature will have to be classified as a liability.

This distinction is now very important for the current/ non-current classification of the underlying debt instrument. If the conversion feature is equity classified, the conversion terms have no impact on the classification of the underlying debt. In that case you can consider just the maturity date of the underlying debt, and if the maturity date more than 12-months after the reporting date, the debt can be classified as non-current.

If the conversion feature is liability classified, the potential timing of conversion will need to be considered in classifying the underlying debt as current or non-current. The amendments meant that if the feature is convertible at any time, the whole debt would need to be classified as current. In other words, the new requirements view conversion of an instrument with a liability classified conversion feature as settlement of the liability. If it can be settled at any time, it is deemed to be ‘at call’ and would be required to be classified as current. Any instrument with a liability classified conversion feature that may require conversion within the next 12-months after reporting date, will result in the underlying debt being classified as current on the statement of financial position.

If your liability classified conversion feature results in the recognition of a derivative, then the classification of the derivative liability will also follow the current/ non-current classification of the underlying debt instrument.

Example
A convertible debt instrument has $1m face value and matures in 4 years with the different conversion features set out below, all of which are at the holders’ discretion, otherwise the $1m in cash will be repayable on maturity. The $1m* will be treated as a debt with a conversion feature, the classification of that debt as either current or non-current depend on the conversion terms.

Conversion terms	Conversion feature classification	Current/ Non-current classification of debt
$1m face value may convert into 1m ordinary shares	Equity	Non-current
$1m face value may convert into ordinary shares at maturity date at the share price at that date	Liability	Non-current^
$1m face value may convert into ordinary shares at a 20% discount to the current market price at any time prior to maturity	Liability	Current

* The initial carrying amount of the debt will be an amount less than $1m reflecting the value attributed to the conversion feature.

^ This arrangement can still be classified as non-current because maturity is in 4 years (more than 12-months after reporting date)

Application date

These amendments are applicable retrospectively and when the debt instruments were issued is irrelevant. When presenting financial statements for years beginning on or after 1 January 2024, all convertible debt outstanding in the current and comparative year, will need to be presented applying the above principles. Consequently, when entering into new convertible debt arrangements, it may be important to consider how the terms may impact the current/non-current classification, especially if the optics on the statement of financial position is important to your organisation and investors.

Accounting for convertible debt arrangements is often complex, and the additional implications of ithese amendments on current/non-current classification exacerbates it further. If you would like to discuss the implications of this amendment on your existing or proposed convertible instruments, please contact your local Moore Australia Advisor.