So we're gonna start by looking at a situation where the bond is going to be treated as a liability, and the option is going to be treated as an equity item under IFRS accounting, the procedure here is to start by taking the fair value of the convertible note.

So this is the whole value of both the bond and also the embedded option.

Once you've done that, then what we do is we value the bond element, and we do that by establishing what the yield of a similar bond, but without the convertible option would have, and then use that to discount the cash flows of the bond to value the bond as though it had no convertible option.

Then of course, the difference between the fair value of the whole convertible versus just the bond element is gonna give us the residual value or the option value.

Now you can see here we've got a little example for you.

So we've got the fair value of the convertible and 105, and that's the whole instrument.

And then we've tried to value the bond element and we have taken the comparable yield of a bond with a similar credit rating, except one without the convertible option.

Got a par value of a hundred.

We've assumed a coupon rate of five.

So the coupon is 5% par value maturity of four years, and we just used the present value function to establish what the price of the bond would be without the convertible of 96.5.

So the difference between 105 and the 96.5 gives us the value of the option here.

Now, if there are any transaction costs, IE issuance costs related to the convertible, these are allocated on a pro-rata basis between the liability and the equity.

If it's allocated to the liability, which is the bond, then that would be typically expense through the effective interest method, and if it's allocated to equity due to the option that will be expensed immediately.

If the bond element is going to be redeemed for either cash or shares and has a cash coupon, then the bond element will be treated as a financial liability.

So this is IFRS accounting for convertibles at its very simplest where we're treating the option as an equity item.