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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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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.

1.

To determine

Prepare journal entries to record bond conversion using (a) book value method and (b) market value method.

Explanation

Induced Conversion: Induced conversion is a method wherein, the convertible bonds issued by the company are converted into common stock in order to reduce interest costs or for increasing the debt-to-equity ratio of the company.

(a).

Prepare journal entry to record conversion of bonds using book value of method.

DateAccount titles and ExplanationDebitCredit
March 1, 2021Bonds payable$300,000  
 Premium on bonds payable (2)$19,200  
      Common stock (1) $75,000
       Additional paid in capital from bond conversion (balancing figure) $244,200
 (To record conversion of bonds)  
March 1, 2023Bonds payable$1,200,000  
 Premium on bonds payable (5)$52,800  
      Common stock (4) $300,000
       Additional paid in capital from bond conversion $952,800
 (To record conversion of bonds)  

Table (1)

As on 1st March 2021:

  • Bonds payable is a liability, and it is decreased. Therefore, debit bonds payable account for $300,000.
  • Premium on bonds payable is an adjunct liability, and it is increased. Therefore, debit discount on bonds payable account for $19,200.
  • Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $75,000.
  • Additional paid in capital on common stock is a component of stockholders’ equity, and it is increased. Therefore, credit additional paid in capital on common stock account for $244,200.

As on 1st March 2023:

  • Bonds payable is a liability, and it is decreased. Therefore, debit bonds payable account for $1,200,000.
  • Premium on bonds payable is an adjunct liability, and it is increased. Therefore, debit discount on bonds payable account for $52,800.
  • Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $300,000.
  • Additional paid in capital on common stock is a component of stockholders’ equity, and it is increased. Therefore, credit additional paid in capital on common stock account for $952,800.

Working notes:

(1) Calculate common stock.

Common stock =(Bonds payableNumber of convertible bonds×Convertible common shares×Face valueper share)=($300,000$1,000)×25Common shares×$10=300×25×$10=$75,000

(2) Calculate premium on bonds payable.

Premium on bonds =Unamortized premium×Converted convertible bondsTotal convertible bonds=$96,000×$300,000$1,500,000=$19,200

(3) Calculate unamortized premium on bonds.

Unamortized premium=Total amount to be amortized Amortized bonds=($1,620,000$1,500,000)(($120,000120months)×24months)=$120,000$24,000=$96,000

(4) Calculate common stock.

Common stock =(Bonds payableNumber of convertible bonds×Convertible common shares×Face valueper share)=($1,200,000$1,000)×25Common shares×$10=1,200×25×$10=$300,000

(5) Calculate premium on bonds payable.

Premiumon bonds=Unamortized premium on bondsTotal number of months×lapsed months=(($96,000120months)×(12024months))=$800per month×66months=$52,800

(b)

Prepare journal entry to record conversion of bonds using market value of method

2.

To determine

Explain whether the company assign a value to a conversion feature under GAAP method, how the evaluation would be determined.

3.

To determine

Compute the company debt to equity ratio under each alternative, assume the company other liabilities are $3,000,000, and the shareholders’ equity before conversion is $3,500,000. Calculate the ratio before and after 1st March 2021.

4.

To determine

Prepare journal entry to record issuance of bonds, assume the company uses IFRS and issued for $1,620,000 on 1st March 2019, and the fair value of each bond was $1,040 and the fair value of conversion option was $40 per bond.

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