Question

On January 1, 2015, when its $30 par value common stock was selling for $80 per share, a corporation issued $10 million of 10% 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 $11 million. At the time of issuance, the present value of the bond payments was $8.5 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 $90 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. CHART OF ACCOUNTS Corporation General Ledger ASSETS 111 Cash 121 Accounts Receivable 141 Inventory 152 Prepaid Insurance 181 Equipment 198 Accumulated Depreciation LIABILITIES 211 Accounts Payable 231 Salaries Payable 250 Unearned Revenue 255 Bonds Payable 256 Premium on Bonds Payable 261 Income Taxes Payable EQUITY 311 Common Stock 315 Additional Paid-In Capital 331 Retained Earnings REVENUE 411 Sales Revenue EXPENSES 500 Cost of Goods Sold 511 Insurance Expense 512 Utilities Expense 521 Salaries Expense 532 Bad Debt Expense 540 Interest Expense 541 Depreciation Expense 559 Miscellaneous Expenses 910 Income Tax Expense PAGE 1 GENERAL JOURNAL DATE ACCOUNT TITLE POST. REF. DEBIT CREDIT 1 2 3 Prepare the journal entry to record the exercise of the conversion option, using the book value method on January 1, 2017. PAGE 1 GENERAL JOURNAL DATE ACCOUNT TITLE POST. REF. DEBIT CREDIT 1 2 3 4

Answer 1

1.

Date	Account Title	Debit	Credit
1/1/2015	Cash	$ 11,000,000.00
	Premium on Bonds		$   1,000,000.00
	Bonds Payable		$ 10,000,000.00
	(To record issuance of bonds)

2.

Date	Account Title	Debit	Credit
1/1/2017	Bonds Payable	$    4,000,000.00
	Premium on Bonds Payable (Calculation 1)	$       320,000.00
	Common Stock, $10 Par (Calculation 2)		$      480,000.00
	Paid in Capital in excess of Par		$   3,840,000.00
	(To record the exercise of the conversion option)

Calculation 1
Premium on Bonds Payable	$    1,000,000.00
Amortization for 2015	$       100,000.00
Amortization for 2016	$       100,000.00
Premium on Bonds Payable on January 2017	$       800,000.00
Bonds Converted	40%
Unamortized premium on bonds converted	$       320,000.00

Calculation 2
Conversion ratio = 6 share per 1000 Bond	120000
Percentage of Bonds converted	40%
Number of Bonds issued	48000
Par Value per share	$               10.00
Total Par Value	$       480,000.00