Question

OGOYA Ltd is a fast-growing company in need of new financing to fund its expansion plans. It is hoping to raise $10 million dollars from a debt issuance. It is considering the following options:

A Issue 2-year 8% debentures at par on January 1, 2019. Interest payments are made annually at the end of each year. The debenture matures on December 31, 2020.

B Issue 2-year 4% convertible debentures at par on January 1, 2019. The debentures can be converted into 10 million $1 shares at maturity on December 31, 2020. Interest payments are made annually at the end of each year. Without the conversion feature, the debenture would be priced the same as option A.

Question show the journal entries for A and B from 1 January 2019 to 31 December 2020 the face value 10 million

Answer 1

Solution:

Journal Entry related to Option A

Date	General Journal	Debit	Credit
Jan.1, 2019	Cash	$10,000,000
	Bonds Payable		$10,000,000
	(Bonds issued at par)
Dec.31, 2019	Interest Expense (10,000,000*8%)	$800,000
	Cash or Interest Payable		$800,000
	(Interest recorded)
Dec.31, 2020	Interest Expense (10,000,000*8%)	$64,000
	Cash or Interest Payable		$64,000
	(Interest recorded)
Dec.31, 2020	Bonds Payable	$10,000,000
	Cash		$10,000,000
	(Repaid on maturity)

Journal Entry related to Option B

Date	General Journal	Debit	Credit
Jan.1, 2019	Cash (Total Proceeds)	$10,000,000
	Liability		$9,286,694
	Share Options (Equity) (Bal fig)		$713,306
Dec.31, 2019	Interest Expense (Refer working below)	$742,936
	Liability (bal. fig)	$342,936
	Interest Payable or Cash (10,000,000*8%)		$400,000
	(Interest recorded)
Dec.31, 2020	Interest Expense (Refer working below)	$770,370
	Liability (bal. fig)	$370,370
	Interest Payable or Cash (10,000,000*8%)		$400,000
	(Interest recorded)
Dec.31, 2020	Liability	$10,000,000
	Share Options (Equity)	$713,306
	Common Stock		$10,000,000
	Additional Paid in Capital in excess of par - common stock		$713,306

Working:

Without the conversion feature, the debenture would be priced the same as option A. It means the interest rate without the conversion feature is 8%.

Present Value of Future Interest payments and principal using 8%
Year
1	$400,000 Interest	x	[1 / 1.08]	=	$370,370
2	$400,000 Interest	x	[1 / 1.08^2]	=	$342,936
2	$10,000,000 (Principal)	x	[1 / 1.08^2]	=	$8,573,388
	TOTAL				$9,286,694

Interest will be charged using 8%. The different between interest paid and interest charged will be added to the liability component as follows:

Year	Interest Expense	$	Liability	$
1	[9,286,694*8%]	$742,936	[9286,694 + 742,936 - 400,000*]	$9,629,630
2	[9,629,630*8%]	$770,370	[9629,630 + 770,370 - 400,000]	$10,000,000
	*$400,000 Coupon Interest at 4% of $10,000,000

Hope the above calculations, working and explanations are clear to you and help you in understanding the concept of question.... please rate my answer...in case any doubt, post a comment and I will try to resolve the doubt ASAP…thank you