Question

On January 1, 2015, when its $30 par value common stock was selling for $60 per share, a corporation issued $20 million of 12% 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 $21 million. At the time of issuance, the present value of the bond payments was $18.50 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 $70 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.

Answer 1

(a)   Cash......................................................................... 21,000,000

                Bonds Payable..............................................                       20,000,000

                Premium on Bonds Payable.......................                         1,000,000

                   (To record issuance of $20,000,000

                    of 12% convertible debentures for

                     $21,000,000. The bonds mature

                     in ten years, and each $1,000

                     bond is convertible into six shares

                     of $30 par value common stock)

(b)   Bonds Payable................................................        8,000,000

        Premium on Bonds Payable

            (Schedule 1) ................................................           320,000

                Common Stock, $10 par

                    (Schedule 2) ........................................                                 1,440,000

                Paid-in Capital in Excess of Par..........                                 6,880,000

                    (To record conversion of 40%

                     of the outstanding 12% convertible

                     debentures after giving effect

                     to the 3-for-1 stock split)

Schedule 1

Computation of Unamortized Premium on Bonds Converted

Premium on bonds payable on January 1, 2015                            $1,000,000

Amortization for 2015 ($1,000,000 ÷ 10)                       $100,000

Amortization for 2016 ($1,000,000 ÷ 10)                       100,000     (200,000)

Premium on bonds payable on January 1, 2017                                  800,000

Bonds converted                                                                                       X    40%

Unamortized premium on bonds converted                                       $320,000

Schedule 2

Computation of Common Stock Resulting from Conversion

Number of shares convertible on January 1, 2015:

    Number of bonds ($20,000,000 ÷ $1,000)                     20,000

    Number of shares for each bond                                    X      6          120,000

Stock split on January 1, 2016                                                                  X        3

Number of shares convertible after the stock split                              360,000

% of bonds converted                                                                               X   40%

Number of shares issued                                                                          144,000

Par value/per share                                                                                    X    $10

Total par value                                                                                        $1,440,000