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Chapter 16: Q41STQ (page 895)

Question: . Mae Jong Corp. issues \(1,000,000 of 10% bonds payable which may be converted into 10,000 shares of \)2 par value ordinary shares. The market rate of interest on similar bonds is 12%. Interest is payable annually on December 31, and the bonds were issued for total proceeds of $1,000,000. In accounting for these bonds, Mae Jong Corp. will:

(a) first assign a value to the equity component, then determine the liability component.

(b) assign no value to the equity component since the conversion privilege is not separable from the bond.

(c) first assign a value to the liability component based on the face amount of the bond.

(d) use the 鈥渨ith-and-without鈥� method to value the compound instrument.

Short Answer

Expert verified

Answer

Correct option: d: use the 鈥渨ith-and-without鈥� method to value the compound instrument.

Step by step solution

01

The explanation for the correct option

A convertible bond alludes to a bond that pays a fixed pay and can be converted into stock offers. This change occurs at a specific time with a specific conversion ratio and price value. Whenever a bond is converted into a ratio and a price value, interestingly, the bond cost is a lot higher than the conversion price. For a given situation, the with-and-without technique can be utilized for a valuation of a compound instrument as this strategy is utilized for non-contend arrangements. Therefore, option d is the correct answer.

02

The explanation for the incorrect options

Option a: A liability component is estimated at a fair worth, and afterwards the rest of the returns are designated to an equity component.

Option b: Allocate no worth to an equity component value part since the transformation honour isn't distinguishable from the bond, and is not a method that will be adopted.

Option c: The Mae Jong Corp will not first assign a value to the liability component based on the face amount of the bond.

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Most popular questions from this chapter

EPS with Contingent Issuance Agreement) Winsor Inc. recently purchased Holiday Corp., a large midwestern home painting corporation. One of the terms of the merger was that if Holiday鈥檚 income for 2017 was \(110,000 or more, 10,000 additional shares would be issued to Holiday鈥檚 stockholders in 2018. Holiday鈥檚 income for 2016 was \)120,000.

Instructions

(a) Would the contingent shares have to be considered in Winsor鈥檚 2016 earnings per share computations?

(b) Assume the same facts, except that the 10,000 shares are contingent on Holiday鈥檚 achieving a net income of $130,000 in 2017. Would the contingent shares have to be considered in Winsor鈥檚 earnings per share computations for 2016?

(Conversion of Bonds) Vargo Company has bonds payable outstanding in the amount of \(500,000, and the Premium on Bonds Payable account has a balance of \)7,500. Each \(1,000 bond is convertible into 20 shares of preferred stock of parvalue of \)50 per share. All bonds are converted into preferred stock.

Four years after issue, debentures with a face value of \(1,000,000 and book value of \)960,000 are tendered for conversion into 80,000 shares of common stock immediately after an interest payment date. At that time, the market price of the debentures is 104, and the common stock is selling at \(14 per share (par value \)10). The company records the conversion as follows. Bonds Payable 1,000,000 Discount on Bonds Payable 40,000 Common Stock 800,000 Paid-in Capital in Excess of Par鈥� Common Stock 160,000 Discuss the propriety of this accounting treatment.

Angela Corporation issues 2,000 convertible bonds at January 1, 2016. The bonds have a 3-year life, and are issued at par with a face value of \(1,000 per bond, giving total proceeds of \)2,000,000. Interest is payable annually at 6%. Each bond is convertible into 250 ordinary shares (par value of $1). When the bonds are issued, the market rate of interest for similar debt without the conversion option is 8%.

Instructions

(a) Compute the liability and equity component of the convertible bond on January 1, 2016.

(b) Prepare the journal entry to record the issuance of the convertible bond on January 1, 2016.

(c) Prepare the journal entry to record the repurchase of the convertible bond for cash at January 1, 2019, its maturity date.

Question: (Conversion of Bonds) On January 1, 2017, Gottlieb Corporation issued \(4,000,000 of 10-year, 8% convertible debentures at 102. Interest is to be paid semi-annually on June 30 and December 31. Each \)1,000 debenture can be converted into eight shares of Gottlieb Corporation \(100 par value common stock after December 31, 2018. On January 1, 2019, \)400,000 of debentures are converted into common stock, which is then selling at \(110. An additional \)400,000 of debentures are converted on March 31, 2019. The market price of the common stock is then $115. Accrued interest at March 31 will be paid on the next interest date. Bond premium is amortized on a straight-line basis.

Make the necessary journal entries for:

(a) December 31, 2018. (c) March 31, 2019.

(b) January 1, 2019. (d) June 30, 2019.

Record the conversions using the book value method
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