Question

Barone Corporation issues 3,000 convertible bonds at January 1, 2018. The bonds have a three year life, and are issued at par with a face value of €1,000 per bond, giving total proceeds of €3,000,000. Interest is payable annually at 6 percent. 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%.

PV of €1 due in 3 years at 8% is 0.79383 PVF of Ordinary Annuity(i=8%, n=3) = 2.57710

(a) Compute the liability and equity component of the convertible bond on January 1, 2018.

(b) Prepare the journal entry to record the issuance of the convertible bond on January 1, 2018.

(c) Prepare the journal entry to record the conversion on January 1, 2019.

(d) Assume that the bonds were repurchased on January 1, 2019, for €2,910,000 cash instead of being converted. The net present value of the liability component of the convertible bonds on January 1, 2019, is €2,750,000. Prepare the journal entry to record the repurchase on January 1, 2019.

Assume that the following data relative to Kane Company for 2012 is available and the tax rate is 40%:

Net Income $6,000,000

Transactions in Ordinary Shares   Change Cumulative

Jan. 1, 2012, Beginning balance of shares 700,000

Mar. 1, 2012, Purchase of treasury shares (60,000) 640,000

June 1, 2012, Share dividends of 20% 128,000 768,000

Nov. 1, 2012, Issuance of shares 552,000 1,320,000

7% Convertible Bonds Payable                                         $2,000,000

Each bond was allocated at a price of face value. The convertible bonds will convert into ordinary shares at 60 shares per $1,000 bond on or before 12-31-2014. It then will convert into ordinary shares at 80 shares per $1,000 bond on or after 1-1-2015. The interest on the liability component of the convertible bonds payable for the calendar year ending December 31,2012, was $140,000.

Share Options                                                    60,000 shares

(60,000 options, one ordinary share per option if exercised) Exercisable at the option price of $35 per share. Average market price in 2012, $60.

Required

1. Compute the weighted average number of shares outstanding on 12-31-2012. (2%)
2. Compute the basic earnings per share for 2012. (Round to the nearest cents.) (2%)

Answer 1

Solution:

a)Computation of liability and equity component of the convertible bond on January 1, 2018

i)Contractual cash flows

Interest per year for 3 year=(€1000*3000)*6%=€ 180,000

Redemption of bond at the end of 3rd year=€3,000,000

ii)Liablity component of bond is the present value of contractual cash flows

=€ 180,000*2.57710+€3,000,000 *0.79383

=€463,878+€2381,490

=€2845,368.

iii)Equity component of bond is;

=Net proceeds-Liablity component

=€3,000,000-€2845,368

=€154,632

b) Journal entry to record the issuance of the convertible bond on January 1, 2018

Bank A/c dr   €3,000,000

To Bonds(Financial Liablity) €2845,368  

ToBonds(Equity) €154,632

(Being convertible bonds issued)

c)

Year	Opening balance of Finacial liablity	Interest Expense @8%	Payment	Closing balance of Finacial liablity
1	€2845,368	€227,629.44	€180,000	€2892,997.44
2	€2892,997.44	€231,439.80	€180,000	€294,4437.24
3	€294,4437.24	€235,555.00	€180,000	0

Balance of liablity component at the begining of year 2 is €2892,997.44 or €2892,997

Journal Entry

Bond(Financial liablity) dr €2892,997

Bond(Equity) dr €154,632

To Contributed Equity € 3047,629

(being share capital issued on conversion of bond)

d)Journal entry to record the repurchase on January 1, 2019.

Bond(Financial Liablity) dr   €2,750,000

To Bank    €2,750,000

(Being bonds repurchase)

The equity component of bond will bw transferred to general reserve after the repurchase of bond.