Question

Instructions On January 1, 2015, when its $30 par value common stock was selling for $70 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 $80 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

Please find below table useful to compute desired results: -

Schedule 1

Computation of Unamortized Premium on Bonds Converted
Premium on bonds payable on January 1, 2017		1,000,000
Amortization for 2015	100,000
Amortization for 2016	100,000
		200,000
Premium on bonds payable on January 1, 2017		800,000
		40%
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
Number of shares for each bond		6
		120,000
Stock split on January 1, 2016		3
		360,000
Bonds Converted		144,000
Number of shares converted		10
Par Value		1,440,000

End results would be as follows: -

Date	Account Title and Explanation	Debit	Credit
1 Jan. 2015	Cash	21,000,000
	Bonds payable		20,000,000
	Premium on bonds payable		1,000,000
(to record issuance of $20,000,000 of 10% convertible debentures for $21,000,000. The bonds mature in 10 years, and each $1000 bond is convertible into six shares of $30 par value common stock)
1 Jan. 2017	Bonds Payable(20million*40%)	8,000,000
	Premium on Bonds Payable (Schedule 1)	320,000
	Common Stock(Schedule 2)		1,440,000
	Additional Paid-in Capital		6,880,000
(to record conversion of 40% of the outstanding 12% convertible debentures after giving effect to the 3-for-1 stock split)