Question

On January 1, 2015, Hacker Inc. issued (sold) $600,000 of 8%, six-year, convertible bonds for gross proceeds of $660,000. Each $1,000 bond was convertible into 20 common shares. Similar non-convertible bonds were yielding 9% at that time.   Interest was paid semi-annually, on June 30 and December 31.

On July 1, 2019, all bondholders exercised the conversion option and converted the bonds to common shares. The interest payment had been made on June 30, 2019, as normal.

The company prepares its financial statements in accordance with IFRS. The market price of the common shares was $65 at the date of conversion.

Prepare journal entries to record:

1. The issuance of the convertible bonds on January 1, 2015
2. Payment of interest and recording of interest expense on June 30, 2015
3. Payment of interest and recording of interest expense on June 30, 2019
4. Conversion of the bonds on July 1, 2019

Answer 1

Convertible Bonds

As mentioned earlier, these bonds entitle the bond holders to convert their bonds into a fixed number of shares of the issuing company usually at the time of their maturity. Thus, convertible bonds have features of both equity as well as liability. Convertible notes do not mandate conversion. They give an option to the bond holders at the time of conversion and it is on their discretion whether they want to convert and get equity shares or opt out and get cash against these bonds.

Face Value of the bond	$1000
Date of Issue	1st January 2015
Time to maturity	5 years
Coupon Rate	8% per annum
Frequency of Coupon Payment	Semi-Annually
Conversion Ratio (This means one bond is equivalent to 20 equity shares of the company at the time of maturity)	20:1
Rate of interest prevailing in the market(rate given for non convertible bonds we can assume it as market rate)	9% per annum

Year	Date	Type of CashFlow	CashFlow	Present Value Factor Calculation	Present Value Factor	Present Value
1	30-Jun-15	Coupon	24000	(1/1.045^1)	0.95694	22966.507
2	31-Dec-15	Coupon	24000	(1/1.045^2)	0.91573	21977.519
3	30-Jun-16	Coupon	24000	(1/1.045^3)	0.87630	21031.118
4	31-Dec-16	Coupon	24000	(1/1.045^4)	0.83856	20125.472
5	30-Jun-17	Coupon	24000	(1/1.045^5)	0.80245	19258.825
6	31-Dec-17	Coupon	24000	(1/1.045^6)	0.76790	18429.498
7	30-Jun-18	Coupon	24000	(1/1.045^7)	0.73483	17635.883
8	31-Dec-18	Coupon	24000	(1/1.045^8)	0.70319	16876.443
9	30-Jun-19	Coupon	24000	(1/1.045^9)	0.67290	16149.706
10	31-Dec-19	Coupon	24000	(1/1.045^10)	0.64393	15454.264
11	30-Jun-20	Coupon	24000	(1/1.045^11)	0.61620	14788.77
12	31-Dec-20	Coupon	24000	(1/1.045^12)	0.58966	14151.933
13	31-Dec-20	Princple	600000	(1/1.09^6)	0.59627	357760.4
			Present Value			576606.33

(Cash flow Semi annually for Coupon Payments = $ 600000*8% * 6/12 = $24000)

b) Equity Portion:

Value of the equity portion will be the difference between the total proceeds received from the bonds and the present value (liability portion).

Calculating the equity portion for the above example:

Total Gross Proceeds recieved = $660000

Present Value of Bond = $ 576606.33

Equity Portion = Total Proceeds – Present Value of Bond = $660000 – $576606.33= $ 83393.67

a)So the very first Journal Entry in the books for issue of Convertible Bonds will be as follows:

01-Jan-2015	Bank A/c	Dr	660000
	10% Convertible Bonds Series I A/c	Cr		416196.12
	Share Premium – Equity Conversion A/c	Cr		83393.67
	(Being 600 convertible bonds issued at 8% coupon rate and maturity 6 years)

Actual Interest Payment = Face Value of Bond * No. of Bonds Issued * Coupon Rate

Effective Interest = Present Value of Liability * Market Rate of Interest

b) Payment of interest and recording of interest expense on June 30, 2015

Effective Interest = $ 576606.33 * 9%/2 = $ 25947.3

Journal Entry for Interest will be as follows:

31-Dec-2016	Interest Expense A/c	Dr	25947.3
	10% Convertible Bonds Series I A/c	Cr		1947.3
	Bank A/c	Cr		24000
	(Being coupon payments made for Semi annually and interest expense accounted for)

c)Payment of interest and recording of interest expense on June 30, 2019

31-Dec-2016	Interest Expense A/c	Dr	25947.3
	10% Convertible Bonds Series I A/c	Cr		1947.3
	Bank A/c	Cr		24000
	(Being coupon payments made for Semi annually and interest expense accounted for)

d) Conversion of bonds before maturity

the conversion takes place on 1st July 2019. At value of liability on this date is $581579.94. Further, the Share Premium – Equity Conversion A/c will be also need to be reversed.

On July 1st 2019 Present Value of liability is as follows

Year	Date	Type of Cashlow	Cashflow	Present Value Factor Calculation	Present Value Factor	Present Value
1	30-Jun-15	Coupon	24000	(1/1.045^1)	0.95694	22966.507
2	31-Dec-15	Coupon	24000	(1/1.045^2)	0.91573	21977.519
3	30-Jun-16	Coupon	24000	(1/1.045^3)	0.87630	21031.118
4	31-Dec-16	Coupon	24000	(1/1.045^4)	0.83856	20125.472
5	30-Jun-17	Coupon	24000	(1/1.045^5)	0.80245	19258.825
6	31-Dec-17	Coupon	24000	(1/1.045^6)	0.76790	18429.498
7	30-Jun-18	Coupon	24000	(1/1.045^7)	0.73483	17635.883
8	31-Dec-18	Coupon	24000	(1/1.045^8)	0.70319	16876.443
9	30-Jun-19	Coupon	24000	(1/1.045^9)	0.67290	16149.706
13	31-Dec-20	Princple	600000	(1/1.09^4.5)	0.67855	407128.97
			Present Value			581579.94

Journal entry for the same will be as follows:

1st July 2019	10% Convertible Bonds Series I A/c	Dr	581579.94
	Share Premium – Equity Conversion A/c	Dr	83393.67
	Equity Share Capital A/c	Cr		600000
	Share Premium A/c	Cr		64973.61
	(Being 12000 shares issued against convertible bonds)

Here, Share Premium A/c will be the balancing figure arrived as follows: 581579.94+83393.67-600000= 64973.61