1.
Prepare journal entries to record bond conversion using (a) book value method and (b) market value method.
1.
Explanation of Solution
Induced Conversion: Induced conversion is a method wherein, the convertible bonds issued by the company are converted into common stock in order to reduce interest costs or for increasing the debt-to-equity ratio of the company.
(a).
Prepare
Date | Account titles and Explanation | Debit | Credit |
March 1, 2021 | Bonds payable | $300,000 | |
Premium on bonds payable (2) | $19,200 | ||
Common stock (1) | $75,000 | ||
Additional paid in capital from bond conversion (balancing figure) | $244,200 | ||
(To record conversion of bonds) | |||
March 1, 2023 | Bonds payable | $1,200,000 | |
Premium on bonds payable (5) | $52,800 | ||
Common stock (4) | $300,000 | ||
Additional paid in capital from bond conversion | $952,800 | ||
(To record conversion of bonds) |
Table (1)
As on 1st March 2021:
- Bonds payable is a liability, and it is decreased. Therefore, debit bonds payable account for $300,000.
- Premium on bonds payable is an adjunct liability, and it is increased. Therefore, debit discount on bonds payable account for $19,200.
- Common stock is a component of
stockholders’ equity , and it is increased. Therefore, credit common stock account for $75,000. - Additional paid in capital on common stock is a component of stockholders’ equity, and it is increased. Therefore, credit additional paid in capital on common stock account for $244,200.
As on 1st March 2023:
- Bonds payable is a liability, and it is decreased. Therefore, debit bonds payable account for $1,200,000.
- Premium on bonds payable is an adjunct liability, and it is increased. Therefore, debit discount on bonds payable account for $52,800.
- Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $300,000.
- Additional paid in capital on common stock is a component of stockholders’ equity, and it is increased. Therefore, credit additional paid in capital on common stock account for $952,800.
Working notes:
(1) Calculate common stock.
(2) Calculate premium on bonds payable.
(3) Calculate unamortized premium on bonds.
(4) Calculate common stock.
(5) Calculate premium on bonds payable.
(b)
Prepare journal entry to record conversion of bonds using market value of method.
Date | Account titles and Explanation | Debit | Credit |
March 1, 2021 | Bonds payable | $300,000 | |
Premium on bonds payable (2) | $19,200 | ||
Common stock (1) | $75,000 | ||
Additional paid in capital from bond conversion (6) | $135,000 | ||
Gain from bond conversion | $109,200 | ||
(To record conversion of bonds) | |||
March 1, 2023 | Bonds payable | $1,200,000 | |
Premium on bonds payable (5) | $52,800 | ||
Common stock (4) | $300,000 | ||
Additional paid in capital from bond conversion (7) | $600,000 | ||
Gain from bond conversion | $352,800 | ||
(To record conversion of bonds) |
Table (2)
As on 1st March 2021:
- Bonds payable is a liability, and it is decreased. Therefore, debit bonds payable account for $300,000.
- Premium on bonds payable is an adjunct liability, and it is increased. Therefore, debit discount on bonds payable account for $19,200.
- Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $75,000.
- Additional paid in capital on common stock is a component of stockholders’ equity, and it is increased. Therefore, credit additional paid in capital on common stock account for $135,000.
- Gain on redemption of bonds is a component of stockholders’ equity, and it is increased. Therefore, credit gain on redemption of bonds account for $109,200.
As on 1st March 2023:
- Bonds payable is a liability, and it is decreased. Therefore, debit bonds payable account for $1,200,000.
- Premium on bonds payable is an adjunct liability, and it is increased. Therefore, debit discount on bonds payable account for $52,800.
- Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $300,000.
- Additional paid in capital on common stock is a component of stockholders’ equity, and it is increased. Therefore, credit additional paid in capital on common stock account for $600,000.
- Gain on redemption of bonds is a component of stockholders’ equity, and it is increased. Therefore, credit gain on redemption of bonds account for $352,800.
Working notes:
(6) Calculate additional paid in capital from bond conversion.
(7) Calculate additional paid in capital from bond conversion.
2.
Explain whether the company assign a value to a conversion feature under GAAP method, how the evaluation would be determined.
2.
Explanation of Solution
The conversion feature would possibly have to be valued by valuing the difference in the yield rates between the convertible bond and an equivalent bond that would have been issued by the company but without a conversion feature. The present value of the future cash flows discounted using this differential rate would be to calculate the average differential yield rate that happens for all companies in the market, and use this value to calculate the present value of the conversion feature.
3.
Compute the company debt to equity ratio under each alternative, assume the company other liabilities are $3,000,000, and the shareholders’ equity before conversion is $3,500,000. Calculate the ratio before and after 1st March 2021.
3.
Explanation of Solution
Compute debt to equity ratio before the conversion.
Compute debt to equity ratio after conversion accounted for with book value method.
Compute debt to equity ratio after conversion computed for with market value method.
4.
Prepare journal entry to record issuance of bonds, assume the company uses IFRS and issued for $1,620,000 on 1st March 2019, and the fair
4.
Explanation of Solution
Prepare journal entry to record issuance of bonds.
Date | Account Titles and Explanation | Debit | Credit |
March 1, 2019 | Cash | $1,620,000 | |
Bonds payable (8) | $1,560,000 | ||
Additional paid in capital – conversion option (4) | $60,000 | ||
(To record issuance of bonds payable) |
Table (3)
- Cash is a current asset, and it is increased. Therefore, debit cash account for $1,620,000.
- Bonds payable is a liability, and it is increased. Therefore, credit bonds payable account for $1,560,000.
- Additional paid in capital – conversion option is a component of stockholders’ equity, and it is increased. Therefore, credit Additional paid in capital – conversion option account for $60,000.
Working note:
(8) Calculate bonds payable.
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Chapter 14 Solutions
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