Question

On 1/1/2018, Husky, Inc. issues $20,000,000 of five-year, 1% convertible bonds at par. Each $1,000 bond in the issue converts to 20 shares of $1 par value common stock at the option of the bondholder beginning two years after issue. The market price of Husky’s common stock on the date of issue is $54 and interest is paid annually each December 31. Assume that half of the bonds were converted on 1/1/2020 and at that date the carrying value (net book value) of the entire issue of convertible bonds is $19,000,000.

Required:

A. Prepare the journal entry for issuance of Husky’s convertible bonds on 1/1/2018. (3 points)

B. Prepare the journal entry for conversion of half of the convertible bonds on 1/1/2020. (4 points)

Answer 1

Solution:

Part A – Journal Entry for Issuance of bonds

Date	General Journal	Debit	Credit
1/1/2018	Cash	$20,000,000
	Convertible Bonds Payable or Bonds Payable		$20,000,000

Note – Bonds are issued at par. Hence the issue price from the bonds = $20,000,000

Part B -- journal entry for conversion of half of the convertible bonds on 1/1/2020

There are two method for recording the conversion from liability to equity.

(1) Book Value Method (2) Market Value Method.

It is assumed that the company is following Book Value method.

Under Book Value method results no gain or loss. The full carrying amount of the bond is split up between common stock and additional paid in capital.

Number of Shares from conversion of 1 Bond = 20 Shares

Total Carrying Value of the bonds as on 1/1/2020 = $19,000,000

Carrying Value of half Bonds that are converted into common stock = $19,000,000/ 2 = $9,500,000

Number of Bonds to be converted = 10,000,000 / 1000 value of each bond x1/2 = 10,000 Bonds x ½ = 5,000 bonds

Number of Shares to be issued from the conversion of bonds = 5,000 Bonds x 20 shares = 100,000 Shares

Par Value of Common Stock = 100,000 Shares x $1 par value = $100,000

Additional Paid in Capital = Carrying Value of the bonds – Par Value of Common Stock = $9,500,000 - $100,000

= $9,400,000

Journal Entry

Date	General Journal	Debit	Credit
1/1/2020	Bonds Payable	$9,500,000
	Common Stock (Par Value)		$100,000
	Additional Paid in Capital (Bal. fig)		$9,400,000

Note --- Since the bonds are issued at par the carrying value must be $20,000,000. But as the question is saying the carrying value of convertible bonds is $19,000,000. The same value is taken for the journal entry.

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