Chapter 14, Problem 14.19P

(1)

To determine

Convertible bond

Convertible bonds are a kind of bonds that can be easily converted into common stock at the option of the issuance of the bond.

Induced Conversion

The investors will not be willing to convert the bonds into shares even if the share prices are high. So, the company will induce the investors to convert the bonds into the stocks in order to reduce the debt-to-equity ratio of the company. The investors may also be benefitted by such conversion, as they can earn more from such converted shares. This process is referred to as induced conversion.

Detachable Stock Purchase Warrants

A stock warrant gives the buyer an option to acquire a declared number of shares of common stock at a specific option price within a particular time period.

To Prepare: The journal entry for the issuance of convertible bonds in 2003.

Explanation of Solution

The following is the journal entry for the issue of bonds:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2003		Cash (1)			195,000,000
		Discount on Bonds Payable (2)			5,000,000
			Convertible Bonds Payable			200,000,000
				(To record issuance of bonds)

Table (1)

Working notes:

Calculate cash received.

$\begin{array}{c}\text{Cash received }=101\%\times \text{Face}\text{value }\\ \text{=}97.5\%\times \$200,000,000\\ =\$195,000,000\end{array}$

Hence, cash received amount is $195,000,000.

(1)

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable}=Convertible\text{Bonds payable}–\text{Cash received}\\ =\$200,000,000-\$195,000,000\\ =\$5,000,000\end{array}$

Hence, discount on bonds payable amount is $5,000,000.

(2)

• Cash is a current asset, and it is increased. Therefore, debit cash account for $195,000,000.
• Discount on bonds payable is a contra liability, and it is increased. Therefore, debit discount on bonds payable account for $5,000,000.
• Convertible bonds payable is a long term liability, and it is increased. Therefore, credit convertible bonds payable account for $200,000,000.

To Prepare: The journal entry to record issue of bonds in 2007.

The following is the journal entry for issuance of bonds:

Date		Account Title and Explanation	Debit ($)	Credit ($)
2007		Cash (3)	51,000,000
		Discount on Bonds Payable (4)	3,000,000
		Bonds Payable		50,000,000
		Equity -  Stock warrants		4,000,000
		(To record the issue of bonds)

Table (2)

Working notes:

Calculate the amount of cash received.

$\begin{array}{c}\text{Cash received = Face value }\times \text{ Issued rate}\\ \text{= \$50,000,000}\times \text{102\%}\\ \text{=}\text{\$51,000,000}\end{array}$

Hence, cash received amount is $51,000,000.

(3)

Calculate discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable }=\left(\begin{array}{l}\text{Bonds payable + Equity-stock warrants }\\ \text{–}\text{Cash received}\end{array}\right)\\ =\$50,000,000+\$4,000,000-\$51,000,000\\ =\$3,000,000\end{array}$

Hence, discount on bonds payable amount is $3,000,000.

(4)

• Cash is a current asset, and it is increased. Therefore, debit cash account for $51,000,000.
• Discount on bonds payable is a contra liability, and it is increased. Therefore, debit discount on bonds payable account for $3,000,000.
• Bonds payable is a long term liability, and it is increased. Therefore, credit bonds payable account for $50,000,000.
• Equity – stock warrants is a component of stockholders’ equity, and it is increased. Therefore, credit equity – stock warrants account for $4,000,000.

(2)

To determine

To Prepare: The journal entry for the conversion of bonds.

Explanation of Solution

The following is the journal entry for conversion of bonds:

Date		Account Title and Explanation			Debit ($)	Credit ($)
		Convertible Bonds Payable (5)			180,000,000
			Discount on Bonds Payable (6)			1,800,000
			Common Stock (7)			178,200,000
				(To record the conversion of bonds)

Table (3)

Working notes:

Calculate the amount of convertible bonds payable.

$\begin{array}{c}\text{Convertible bonds payable = 90\% }\times \text{\$200,000,000}\\ \text{= \$180,000,000}\end{array}$

Hence, convertible bonds payable amount is $180,000,000.

(5)

Calculate the amount of discount on bond payable.

$\begin{array}{c}\text{Discount on bonds payable = 90\% }\times \$200,000,000\\ =\$1,800,000\end{array}$

Hence, discount on bonds payable amount is $1,800,000.

(6)

Calculate the value of common stock.

$\begin{array}{c}\text{Common stock = Convertible bond payable – Discount on bond payable}\\ \text{= \$180,000,000 +\$1,800,000}\\ \text{=\$178,200,000}\end{array}$

Hence, the common stock value is $178,200,000.

(7)

• Convertible bonds payable is a long term liability, and it is decreased. Therefore, debit convertible bonds payable account for $180,000,000.
• Discount on bonds payable is a contra liability, and it is decreased. Therefore, credit discount on bonds payable account for $1,800,000.
• Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $178,200,000.

To determine

To Prepare: The journal entry to record the retirement of the bonds.

Explanation of Solution

The following is the journal entry to record the retirement of the bonds:

Date		Accounts and Explanations	Debit ($)	Credit  ($)
		Convertible Bonds Payable (8)	20,000,000
		Loss on Early Extinguishment of Bonds (10)	400,000
		Discount on Bonds Payable (9)		200,000
		Cash		20,200,000
		(To record early retirement of bonds)

Table (4)

Working notes:

Calculate the amount of convertible bonds payable.

$\begin{array}{c}\text{Convertible bonds payable = 10\% }\times \text{\$200,000,000}\\ \text{= \$20,000,000}\end{array}$

Hence, convertible bonds payable amount is $20,000,000.

(8)

Calculate the amount of discount on bonds payable.

$\begin{array}{c}\text{Discount on bonds payable }=\text{\$2,000,000}\times \frac{10}{100}\\ =\$200,000\end{array}$

Hence, discount on bonds payable amount is $200,000.

(9)

Calculate the amount of loss on early extinguishment.

$\begin{array}{c}\text{Loss on early extinguishment = }\left(\begin{array}{l}\text{Cash paid + Discount on bonds payable}\\ \text{ – Convertible bonds payable}\end{array}\right)\\ =\$20,200,000+\$200,000-\$20,000,000\\ =\$400,000\end{array}$

Hence, Loss on early extinguishment amount is $400,000.

(10)

• Convertible bonds payable is a long term liability, and it is decreased. Therefore, debit convertible bonds payable account for $20,000,000.
• Loss on early extinguishment of bonds is a component of stockholders’ equity, and it is decreased. Therefore, debit loss on early extinguishment of bonds amount is $400,000.
• Discount on bonds payable is a contra liability, and it is decreased. Therefore, credit discount on bonds payable account for $200,000.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $20,200,000.

(3)

To determine

To Prepare: The journal entry for the conversion of bonds.

Explanation of Solution

The following is the journal entry for conversion of bonds:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2017		Convertible Bonds Payable (11)			180,000,000
January		Conversion Expense (12)			27,000,000
			Discount on Bonds Payable (13)			1,800,000
			Common Stock (15)			178,200,000
			Cash (14)			27,000,000
				(To record the conversion of bonds)

Table (5)

Working notes:

Calculate the amount of convertible bonds payable.

$\begin{array}{c}\text{Convertible bonds payable = 90\% }\times \text{\$200,000,000}\\ \text{= \$180,000,000}\end{array}$

Hence, convertible bonds payable amount is $180,000,000.

(11)

Calculate the amount of conversion expense.

$\begin{array}{c}\text{Conversion expense = 90\%}\times \text{200,000 bonds}\times \text{\$150}\\ \text{= \$27,000,000}\end{array}$

Hence, conversion expense amount is $27,000,000.

(12)

Calculate the amount of discount on bond payable.

$\begin{array}{c}\text{Discount on bonds payable = 90\% }\times \$200,000,000\\ =\$1,800,000\end{array}$

Hence, discount on bonds payable amount is $1,800,000.

(13)

 Calculate cash paid.

$\begin{array}{c}\text{Cash paid = 90\%}\times \text{200,000 bonds}\times \text{\$150}\\ \text{= \$27,000,000}\end{array}$

Hence, cash paid amount is $27,000,000.

(14)

Calculate the value of common stock.

$\begin{array}{c}\text{Common stock = }\left[\begin{array}{l}\left(\text{Convertible bond payable + Conversion expense}\right)\\ \text{– }\left(\text{Discount on bond payable + Cash paid}\right)\end{array}\right]\\ \text{= }\left(\text{\$180,000,000}\text{+}\text{\$27,000,000}\right)\text{ –}\left(\text{\$1,800,000 +\$27,000,000}\right)\\ \text{=\$178,200,000}\end{array}$

Hence, common stock amount is $178,200,000.

(15)

• Convertible bonds payable is a long term liability, and it is decreased. Therefore, debit convertible bonds payable account for $180,000,000.
• Conversion expense is a component of stockholders’ equity, and it is decreased. Therefore, debit conversion expense account for $27,000,000.
• Discount on bonds payable is a contra liability, and it is decreased. Therefore, credit discount on bonds payable account for $1,800,000.
• Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $178,200,000.
• Cash is a current asset, and it is decreased. Therefore, credit cash account for $27,000,000.

(4)

To determine

To Prepare: The journal entry for the conversion of bonds.

Explanation of Solution

The following is the journal entry for conversion of bonds:

Date		Account Title and Explanation			Debit ($)	Credit ($)
2017 January		Convertible Bonds Payable (16)			180,000,000
		Conversion Expense (17)			28,800,000
			Discount on Bonds Payable (18)			1,800,000
			Common Stock (19)			207,000,000
				(To record the conversion of bonds)

Table (6)

Working notes:

Calculate the amount of convertible bonds payable.

$\begin{array}{c}\text{Convertible bonds payable = 90\% }\times \text{\$200,000,000}\\ \text{= \$180,000,000}\end{array}$

Hence, convertible bonds payable amount is $180,000,000.

(16)

Calculate the amount of conversion expense.

$\begin{array}{c}\text{Conversion expense = }\left(\text{90\%}\times \text{200,000 bonds}\times \left(\text{45–40}\right)\text{shares}\right)\times \$32\\ \text{= \$28,800,000}\end{array}$

Hence, conversion expense amount is $28,800,000.

(17)

Calculate the amount of discount on bond payable.

$\begin{array}{c}\text{Discount on bonds payable = 90\% }\times \$200,000,000\\ =\$1,800,000\end{array}$

Hence, discount on bonds payable amount is $1,800,000.

(18)

Calculate the value of common stock.

$\begin{array}{c}\text{Common stock = }\left[\begin{array}{l}\left(\text{Convertible bond payable + Conversion expense}\right)\\ \text{–}\text{Discount on bond payable}\end{array}\right]\\ \text{= }\left(\text{\$180,000,000}\text{+}\text{\$28,800,000}\right)\text{ –\$1,800,000}\\ \text{=\$207,000,000}\end{array}$

Hence, common stock amount is $207,000,000.

(19)

• Convertible bonds payable is a long term liability, and it is decreased. Therefore, debit convertible bonds payable account for $180,000,000.
• Conversion expense is a component of stockholders’ equity, and it is decreased. Therefore, debit conversion expense account for $28,800,000.
• Discount on bonds payable is a contra liability, and it is decreased. Therefore, credit discount on bonds payable account for $1,800,000.
• Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $207,000,000.

(5)

To determine

To Prepare: The journal entry to record the exercise of the warrants in December 2017.

Explanation of Solution

The following is the journal entry for exercise of warrants on December, 2017:

Date		Account Title and Explanation			Debit ($)	Credit ($)
December 2017		Cash (20)			20,000,000
		Equity- Stock warrants (21)			1,600,000
			Common Stock (22)			21,600,000
				(To record the exercise of warrants)

Table (7)

Working notes:

Calculate the amount of cash received from exercise.

$\begin{array}{c}\text{Cash received = }\left(\begin{array}{l}\text{Exercise price per warrants }\\ \times \text{ Number of warrants }\\ \times \text{ Number of bonds}\times \text{20\%}\end{array}\right)\\ =\$25\times 4\text{0}\text{warrants}\times 50,000\text{bonds}\times 4\text{0\%}\\ \text{=\$20,000,000}\end{array}$

Hence, cash received amount is $20,000,000.

(20)

Calculate the amount of equity-stock warrants for exercise.

$\begin{array}{c}\text{Equity- Stock warrants = Total equity stock warrants }\times \text{ 20\%}\\ \text{=}\text{\$4,000,0000}\times 4\text{0\%}\\ \text{=}\text{\$1,600,000}\end{array}$

Hence, equity – stock warrants amount is $1,600,000.

(21)

Calculate the amount of common stock.

$\begin{array}{c}\text{Common stock = Cash received + Equity – stock warrants}\\ \text{= \$20,000,000 + \$1,600,000}\\ \text{= \$21,600,000}\end{array}$

Hence, Common stock amount is $21,600,000.

(22)

• Cash is a current asset, and it is increased. Therefore, debit cash account for $20,000,000.
• Equity – stock warrants is a component of stockholders’ equity, and it is decreased. Therefore, debit equity – stock warrants account for $1,600,000.
• Common stock is a component of stockholders’ equity, and it is increased. Therefore, credit common stock account for $21,600,000.