Textbook Problem

Wedge Corporation issued $1,500,000 of 10% convertible bonds for $1,620,000 on March 1, 2019. The bonds are dated March 1, 2019, pay interest semiannually on August 31 and February 28, and the premium is amortized using the straight-line method. The bonds are due on February 28, 2029, and each $1,000 bond is convertible into 25 shares of Wedge’s $10 par common stock. On March 1, 2021, when the shares were selling for $28 per share, $300,000 of bonds were converted. On September 1, 2023, when the shares were selling for $30 per share, the remainder of the bonds were converted.

Required:

1. 1. Prepare the journal entries to record each bond conversion using (a) the book value method and (b) the market value method.
2. 2. Next Level If the company were required under GAAP to assign a value to the conversion feature, explain how the valuation would be determined (no calculations are required).
3. 3. Compute the company’s debt-to-equity ratio (total liabilities divided by total shareholders’ equity, as mentioned in Chapter 6) under each alternative. Assume the company’s other liabilities arc $3 million, and that shareholders’ equity before conversion is $3.5 million. Compute the ratio right before and right alter the March 1, 2018, transaction under each alternative.
4. 4. Assume the company uses IFRS and issued the bonds for $1,620,000 on March 1, 2016. On this date, it determined that the fair value of each bond was $1,040 and the fair value of the conversion option was $40 per bond. Prepare the journal entry to record the issuance of the bonds.