Question

On January 1, 2015, when its $30 par value common stock was selling for $60 per share, a corporation issued $30 million of 12% convertible debentures due in 10 years. The conversion option allowed the holder of each $1,000 bond to convert it into six shares of the corporation’s $30 par value common stock. The debentures were issued for $31 million. At the time of issuance, the present value of the bond payments was $28.50 million, and the corporation believes the difference between the present value and the amount paid is attributable to the conversion feature. On January 1, 2016, the corporation’s $30 par value common stock was split 3 for 1. On January 1, 2017, when the corporation’s $10 par value common stock was selling for $70 per share, holders of 40% of the convertible debentures exercised their conversion options. The corporation uses the straight-line method for amortizing any bond discounts or premiums.

Required:

1. Prepare the journal entry to record the original issuance of the convertible debentures.

2. Prepare the journal entry to record the exercise of the conversion option, using the book value method.

Answer 1

Answer: Let’s first calculate the unamortized Premium on the Bonds Converted and also computation of common stock resulting from conversion.

Schedule 1

Calculation of Unamortized Premium on the Bonds Converted

Information available in the Question
Premium on Bond Payable as on Jan 01,2015	$10,00,000
(31$ Million - 30 $ Million)
Duration of Bond	10 years
Bonds converted	40%
Amortisation Basis	Straight Line Method

Particulars	Amount
Amount available for amortisation	$10,00,000
Amortisation for 2015 (10,00,000/10)	$1,00,000
Amortisation for 2016 (10,00,000/10)	$1,00,000
Premium on bonds payable on January 1,2017	$8,00,000
Bond Conversion	40%
Unamortised Premium on Bonds Converted	$3,20,000

Schedule 2

Calculation of Common Stock resulting from conversion :

Information available in the Question
Number of Shares from each bond converted	6 shares
Stock Split	3 for 1
Particulars	Amount
No. of Bonds convertible ($ 30 Million/ $ 1000)	$30,000
N. of shares converted (30,000*6)	$1,80,000
Stock Split (3 for 1) (1,80,000*3)                                  A	$5,40,000
Option excercised                                            B	40%
No of shares Issued (A*B)	216000
Par Value Per Share	10
Total Par Value	$21,60,000

1. Prepare the journal entry to record the original issuance of the convertible debentures.

Cash Account Dr.............$ 31 Million

Bond Payable ...........................................$ 30 Million

Premium on Bond Payable.......................$ 1 Million

(To record issuance of $ 30 Million of 12% convertible debentures for $31Million. The bonds mature in ten years, and each $1,000 bond is convertible into six shares)

2. Prepare the journal entry to record the exercise of the conversion option, using the book value method.

Bond Payable Dr( 30 $ Million* 40%)...................1,20,00,000 $

To Premium on Bond Payable (Schedule 1).............................$ 320,000

To Common Stock , $ 10 par value (Schedule 2).....................$ 21,60,000

To Paid in Capital in Excess of Par...........................................$ 95,20,000

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