Question

On 1 January 2018, Bae Limited issued a convertible bond with a par value of $100,000 for $120,000.

1. The bonds are convertible into 12,000 ordinary shares of Jan.

2. The bond has a 5-year life with a stated interest of 10% per annum. Interest

   payment is made each year on 31 December, starting from 31 December 2018.

3. The market interest rate on 1 January 2018 for a similar non-convertible bond is

   8% per annum.

4. On 1 January 2018, the liability component of the bond is computed to be $107,986.

5. On 31 December 2019, after the interest has been recorded, Jan Limited

   repurchases the bond for $111,000 cash. At that time the fair value of the liability component is $108,000.

Date

  Cash paid. Interest expense.   Premium amortised   Carrying amount of liability

1 January 2018. $107,986
31 December 2018 $10,000 $8,639 $1,361 $106,625

31 December 2019.   $10,000.   $8,530   $1,470   $105,155

1.Prepare the journal entry to record the issuance of the convertible bond on 1 January 2018.

2. Calculate the loss on repurchase for the liability component of the bond on 31 December 2019.

3. Calculate the adjustment on the equity component of the bond on 31 December 2019.

4. Prepare the journal entries to record the repurchase of bonds on 31 December 2019.

Answer 1

1. When convertible bonds are issued, at the time of issuance, the equity as well as liability (debt) portion of bond must be identified and separately recorded. The equity portion is calculated using residual approach as the proceeds from the sale of convertible bonds less present value of the liability portion of the bond (i.e. present value of all future cash flows from the bond assuming it is non-convertible bond).

Here, we are given that the liability component on the bond as on January 1,2018 is $107,986.

Further, proceeds from sale of bonds = $120,000

Therefore, equity portion = $120,000 - $107,986

                                               = $12,014

So, the journal entry to record the issuance of convertible bonds on 1 January,2018 will be:

Date	Particulars	Debit amount	Credit amount
1-Jan-18	Bank A/c	$120,000
	10% convertible bonds A/c		$107,986
	Share premium - Equity Conversion A/c		$12,014

Here, 10% convertible bonds represents liability portion and Share Premium-Equity Conversion A/c represents the equity portion that will be recorded under the Equity section of balance sheet.

2.

Date	Cash paid (Coupon Interest @10%)	Interest expense (8% of carrying amount of liability)	Premium amortised (Coupon interest - Interest expense @8%)	Carrying amt. of liability
1-Jan-18				$107,986
31-Dec-18	$10,000	$8,639	$1,361	$106,625
31-Dec-19	$10,000	$8,530	$1,470	$105,155

Loss on repurchase for the liability component of the bond is the difference between the fair value of liability and the Carrying value of liability.

Fair value of liability on date of repurchase = $108,000

Carrying value of liability on date of repurchase = $105,155

Loss on repurchase = $108,000- $105,155

                                     = $2,845

3.

Equity adjustment = Market value of bonds – Fair value of liability

Market value of bonds on Dec. 31, 2019 = $111,000

Fair value of liability on Dec. 31, 2019 = $105,155

Equity adjustment = $111,000 - $108,000

                                  = $3,000

4.

The journal entry to record the repurchase of bonds on Dec. 31, 2019 will be as follows:

Date	Particulars	Debit amount	Credit amount
31-Dec-19	10% convertible bonds A/c	$105,155
	Share premium - Equity Conversion A/c	$3,000
	Loss on repurchase of bonds A/c	$2,845
	Bank A/c		$111,000