What basis is used to measure the liability component of convertible loan stock?

The measurement of the liability component of convertible loan stock is based on the present value of future expected cash flows. This approach is rooted in the principles of financial reporting which emphasize recognizing liabilities based on their economic value rather than their nominal amounts or historical costs.

When a convertible loan stock is issued, it typically entails both a liability component (reflecting the obligation to repay the principal and pay interest) and an equity component (the option to convert the loan into equity). The liability component is measured at the present value of the expected cash flows associated with the loan, which includes all future interest payments and the principal repayment at maturity. The present value is calculated using an appropriate market interest rate, which reflects the terms of the loan as well as the issuer's creditworthiness.

This method allows the financial statements to more accurately reflect the company's financial position and performance by incorporating time value of money principles. Therefore, the present value of future expected cash flows provides a realistic view of the financial obligation that the company holds regarding the convertible loan stock.