Question

On January 1, 2015, when its $30 par value common stock was selling for $80 per share, a corporation issued $10 million of 10% convertible debentures due in 10 years. The conversion option allowed the holder of each $1,000 bond to convert it into six shares of the corporation’s $30 par value common stock. The debentures were issued for $11 million. At the time of issuance, the present value of the bond payments was $8.5 million, and the corporation believes the difference between the present value and the amount paid is attributable to the conversion feature. On January 1, 2016, the corporation’s $30 par value common stock was split 3 for 1. On January 1, 2017, when the corporation’s $10 par value common stock was selling for $90 per share, holders of 40% of the convertible debentures exercised their conversion options. The corporation uses the straight-line method for amortizing any bond discounts or premiums. Required: 1. Prepare the journal entry to record the original issuance of the convertible debentures. 2. Prepare the journal entry to record the exercise of the conversion option, using the book value method.

Entry 1 (3 Accounts): Prepare the journal entry to record the original issuance of the convertible debentures on January 1, 2015.

Entry 2 (4 Accounts): Prepare the journal entry to record the exercise of the conversion option, using the book value method on January 1, 2017.

Answer 1

Solution:

1) Preparing the Journal Entries to Record the Original Issuance of the Convertible Debentures:

Date	Account Title and Explanation	Debit	Credit
Jan 1, 2015	Cash	$11,000,000
	Bonds Payable		$10,000,000
	Premium on Bonds Payable		$1,000,000
	(To record issuance of $10,000,000 of 10% convertible debentures for $11,000,000. Thebonds mature in 10 years, and each $1,000 bond is convertible into six shares of $30 par value common stock)

2) Preparing the Journal Entry to Record the Exercise of the Conversion Option, Using the Book Value:

Date	Account Title and Explanation	Debit	Credit
Jan 1, 2017	Bonds Payable	$4,000,000
	Premium on Bonds Payable (Schedule 1)	$320,000
	Common Stock, $10 par (Schedule 2)		$720,000
	Additional Paid-In Capital		$3,600,000
	(To record conversion of 40% of the outstanding 10% convertible debentures after giving effect to the 3-for-1 stock split)

Computations:

Schedule 1:

Computation of Unamortized Premiumon Bonds Converted
Premium on bonds payable on January 1, 2017		$1,000,000
Amortization for 2015 ($1,000,000/10)	$100,000
Amortization for 2016 ($1,000,000/10)	$100,000
		($200,000)
Premium on bonds payable on January 1, 2017		$800,000
		40%
Bonds converted		$320,000

Schedule 2:

Computation of Common Stock Resulting from Conversion
Number of shares convertible on January 1, 2015:
Number of bonds ($10,000,000 / $1,000)	10,000
Number of shares for each bond	*6
	60,000
Stock split on January 1, 2016	* 3
	180,000
Bonds converted	72,000
Number of shares converted	* $10
Par value	$720,000