Question

On January 2, 2014, Zamarano, Inc. issued 5,000 10-year, 6%, $1,000 bonds fat par. Interest is paid each December 31. The market rate of interest for non-convertible bonds is 5%. Each bond is convertible into 25 shares of Zamarano $2 Par Value common stock after two years. The market value of the stock on the date of the issue was $45. On January 2, 2018, when the carrying value of the bonds was $4,570,363, all of the bondholders converted the bonds to stock. Zamarano reports under GAAP.

Required:

1) Prepare the journal entry to record the issuance of the bonds.

2) Recompute the interest rate of the bond issue.

3) Record the first interest payment.

4) Record the conversion of the bonds.

Answer 1

1) Journal Entry to record the issuance of bonds

Bank A/c Dr. $5,000,000

To Borrowings $5,000,000

(Being 5,000 10 year , 6% bond has been issued at par @$1,000)

2) Recomputed Interest rate

Date	Cash flow
02 January 2014	5,000,000
31 December 2014	-             300,000
31 December 2015	-             300,000
31 December 2016	-             300,000
31 December 2017	-             300,000
02 January 2018	-         4,570,363
	3.97%

Effective Interest rate comes to approx 4% considering the shares was given equivalent to bond value of $ 4,570,363/-

3) First Interest payment

Interest Expenses A/c Dr. 300,000

To Interest payable 300,000

(Being Interest paid on bond @6% on $5 millions)

4) Borrowings A/c Dr. 5,000,000

To capital stock $250,000

To Share premium $4,750,000

(Being shares issued by the Company, 25 shares to each bond holder)