Chapter 14, Problem 14.24E

Convertible bonds

• LO14–5

On January 1, 2018, Gless Textiles issued $12 million of 9%, 10-year convertible bonds at 101. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 40 shares of Gless’s no par common stock. Bonds that are similar in all respects, except that they are nonconvertible, currently are selling at 99 (that is, 99% of face amount). Century Services purchased 10% of the issue as an investment.

Required:

1. Prepare the journal entries for the issuance of the bonds by Gless and the purchase of the bond investment by Century.

2. Prepare the journal entries for the June 30, 2022, interest payment by both Gless and Century assuming both use the straight-line method.

3. On July 1, 2023, when Gless’s common stock had a market price of $33 per share, Century converted the bonds it held. Prepare the journal entries by both Gless and Century for the conversion of the bonds (book value method).

To determine

Bonds

Bonds are a kind of interest bearing notes payable, usually issued by companies, universities and governmental organizations. It is a debt instrument used for the purpose of raising fund of the corporations or governmental agencies. If selling price of the bond is equal to its face value, it is called as par on bond. If selling price of the bond is lesser than the face value, it is known as discount on bond. If selling price of the bond is greater than the face value, it is known as premium on bond.

Convertible bond

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

To Prepare: The journal entry to record the issuance of bonds by G (issuer) and purchases of bond investment by C.

Explanation of Solution

Prepare the journal entry to record the issuance of the bonds by G (issuer) as shown below:

Date	Account titles and Explanation	Debit	Credit
January 1, 2018	Cash	$12,120,000
	Premium on bonds payable		$120,000
	Convertible bonds payable		$12,000,000
	(To record the issuance of the bonds)

Table (1)

Working notes:

Calculation of the cash received amount as shown below:

$\begin{array}{c}\text{Cash received}=101\%\times \text{Face}\text{value }\\ \text{=}101\%\times \$12,000,000\\ =\$12,120,000\end{array}$

Hence, cash received amount is $12,120,000.

Calculation of the premium on bonds payable as shown below:

$\begin{array}{c}\text{Premium on bonds payable}=\text{Cash received}–\text{Bonds payable}\\ =\$12,120,000-\$12,000,000\\ =\$120,000\end{array}$

Hence, premium on bonds payable amount is $120,000.

• Cash is a current asset, and increased. Therefore, debit cash account for $12,120,000.
• Premium on bonds payable is an adjunct liability, and increased. Therefore, credit premium on bonds payable account for $120,000.
• Convertible bonds payable is a long term liability, and increased. Therefore, credit convertible bonds payable account for $12,000,000.

Prepare the journal entry to record the purchases of the bonds by C (investor) as shown below:

Date	Account titles and Explanation	Debit	Credit
January 1, 2018	Investment in convertible bonds	$1,200,000
	Premium on bonds payable	$12,000
	Cash		$1,212,000
	(To record the purchases of the bonds)

Table (2)

Working notes:

Calculation of the amount of investment in convertible bonds as shown below:

$\begin{array}{c}\text{Investment in convertible bonds}=\text{10\%}\times \text{Face value}\\ =\text{10\%}\times \text{\$12,000,000}\\ =\text{\$1,200,000}\end{array}$

Hence, investment in convertible bonds amount is $1,200,000.

Calculation of the amount of cash paid as shown below:

$\begin{array}{c}\text{Cash paid}=\text{101\%}\times \text{Investment in convertible bond}\\ =\text{101\%}\times \text{\$1,200,000}\\ =\text{1,212,000}\end{array}$

Hence, cash paid amount is $1,212,000.

Calculation of the premium on bonds investment as shown below:

$\begin{array}{c}\begin{array}{l}\text{Discount on}\\ \text{bonds investment}\end{array}\}=\text{Cash}\text{paid}-\text{Investment in convertible bonds }\\ =\$1,212,000-\$1,200,000\\ =\$12,000\end{array}$

Hence, premium of bonds investment is $12,000.

• Investment in convertible bonds is non – current asset, and increased. Therefore, debit investment in convertible bonds account for $1,200,000.
• Premium on bonds payable is an adjunct liability, and decreased. Therefore, debit premium on bonds payable account for $12,000.
• Cash is a current asset, and decreased. Therefore, credit cash account for $1,212,000.

To determine

To Prepare: The journal entry to record the interest payment by both the Company G (Issuer), Company C (Investor) using the straight line method.

Explanation of Solution

Prepare the journal entry to record the interest payment by the Company G (issuer) as on 30^th June 2022 shown below:

Date	Account titles and Explanation	Debit	Credit
June 30, 2022	Interest expenses	$534,000
	Premium on bonds payable	$6,000
	Cash		$540,000
	(To record the payment of interest expenses)

Table (3)

Working notes:

Calculation of the amount of cash paid for interest as shown below:

$\begin{array}{c}\text{Cash paid}=\text{\$12,000,000}\times 9\text{\%}\times \frac{6}{12}\\ =\$540,000\end{array}$

Hence, cash paid amount is $540,000.

Calculation of the premium on bonds payable as shown below:

$\begin{array}{c}\text{ Premium on bonds payable }=\frac{\text{Total bond}\text{premium }}{\text{Number of premium}}\\ =\frac{\$120,000}{40}\\ =\$6,000\end{array}$

Hence, premium on bonds payable amount is $56,000.

Calculation of the interest expense on the bond as shown below:

$\begin{array}{c}\text{Interest}\text{Expense}=\text{Cash paid}-\text{Premium}\text{on}\text{bond}\text{payable}\\ =\$540,000-\$6,000\\ =\$534,000\end{array}$

Hence, interest expenses amount is $534,000.

• Interest expenses are a component of stockholders’ equity, and decreased it. Therefore, debit interest expenses account for $534,000.
• Premium on bonds payable is an adjunct liability, and decreased. Therefore, debit premium on bonds payable account for $56,000.
• Cash is a current asset, and decreased. Therefore, credit cash account for $540,000.

Prepare the journal entry to record the interest payment by the Company C (Investor) as on 30^th June 2022 shown below:

Date	Account titles and Explanation	Debit	Credit
June 30, 2022	Cash	$54,000
	Premium on bonds payable		$600
	Interest revenue		$53,400
	(To record the receipt of interest revenue)

Table (4)

Working notes:

Calculation of the amount of cash received for interest as shown below:

$\begin{array}{c}\text{Cash received}=\text{\$1,200,000}\times 9\text{\%}\times \frac{6}{12}\\ =\$54,000\end{array}$

Hence, cash received amount is $54,000.

Calculation of the premium on bonds investment as shown below:

$\begin{array}{c}\text{ Premium on bonds investment}=\frac{\text{Total bond}\text{investment}\text{premium }}{\text{Number of premium}}\\ =\frac{\$12,000}{20}\\ =\$600\end{array}$

Hence, premium on bonds payable amount is $600.

Calculation of the interest revenue on the bond investment as shown below:

$\begin{array}{c}\text{Interest}\text{Revenue}=\text{Cash received}-\text{Premium}\text{on}\text{bond}\text{investment}\\ =\$54,000-\$600\\ =\$53,400\end{array}$

Hence, interest revenue amount is $534,000.

• Cash is a current asset, and increased. Therefore, debit cash account for $54,000.
• Premium on bonds payable is an adjunct liability, and increased. Therefore, credit premium on bonds payable account for $600.
• Interest revenue is a component of stockholders’ equity, and increased it. Therefore, credit interest revenue account for $53,400.

To determine

To Prepare: The journal entry to record conversion of bonds from common stock for Company G (Issuer) and Company C (Issuer) as on 1^st July 2023.

Explanation of Solution

Prepare the journal entry to record the conversion of bonds from common stock for Company G (Issuer) as on 1^st July 2023 shown below:

Date	Account titles and Explanation	Debit	Credit
July1, 2023	Convertible bonds payable	1,200,000
	Premium on bonds payable		$5,400
	Common stock		$1,205,400
	(To record the conversion of bonds into common stock)

Table (5)

Working notes:

Calculation of the amount of convertible bonds payable as shown below:

$\begin{array}{c}\text{Convertible bonds payable}=\text{10\%}\times \text{\$12,000,000}\\ =\text{\$1,200,000}\end{array}$

Hence, convertible bonds payable amount is $1,200,000.

Calculation of the amount of premium on bond payable as shown below:

$\begin{array}{c}\text{Premium on bonds payable}=\text{10\%}\times \left(\text{\$120,000 –}\left(\text{\$6,000}\times \text{11}\right)\right)\\ =10\%\times \$54,000\\ =\$5,400\end{array}$

Hence, premium on bonds payable amount is $5,400.

Calculation of the value of common stock as shown below:

$\begin{array}{c}\text{Common stock}=\text{Convertible bond payable}+\text{Premium on bond payable}\\ =\text{\$1,200,000}+\text{\$5,400}\\ =\text{\$1,205,400}\end{array}$

Hence, common stock amount is $1,205,400.

• Convertible bonds payable is a long term liability, and decreased. Therefore, debit convertible bonds payable account for $1,200,000.
• Premium on bonds payable is an adjunct liability, and increased. Therefore, credit premium on bonds payable account for $5,400.
• Common stock is a component of stockholders’ equity, and increased it. Therefore, credit common stock account for $1,205,400.

Prepare the journal entry to record the conversion of bonds from common stock for Company C (Investor) as on 1^st July 2023 shown below:

Date	Account titles and Explanation	Debit	Credit
July1, 2023	Investment in common stock	1,205,400
	Premium on bonds payable		$5,400
	Investment in convertible bonds		$1,200,000
	(To record the conversion of bonds into common stock)

Table (6)

Working notes:

Calculation of the amount of premium on bond investment as shown below:

$\begin{array}{c}\text{Premium on bonds investment}=\text{\$12,000 –}\left(\text{\$600}\times \text{11}\right)\\ =\$5,400\end{array}$

Hence, premium on bond investments amount is $5,400.

Calculation of the investment in convertible bonds as shown below:

$\begin{array}{c}\text{Investment in convertible bonds}=\left(\begin{array}{l}\text{Investment in common stock }\\ \text{– Premium on bonds investment}\end{array}\right)\\ =\$1,205,400-\$5,400\\ =\$1,200,000\end{array}$

Hence, investment in convertible bonds amount is $1,200,000.

• Investment in common stock is a non – current asset, and increased. Therefore, debit investment in common stock account for $1,205,400.
• Premium on bonds payable is an adjunct liability, and increased it. Therefore, credit premium on bonds payable account for $5,400.
• Investment in convertible bonds is a long term liability, and increased. Therefore, credit investment in convertible bonds account for $1,200,000