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Chapter 16: Q6IFRS (page 895)
What are the arguments for giving separate accounting recognition to the conversion feature of debentures?
There is an inborn economic value in a conversion feature.
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EXCEL (Entries for Conversion, Amortization, and Interest of Bonds) Volker Inc. issued \(2,500,000 of convertible 10-year bonds on July 1, 2017. The bonds provide for 12% interest payable semiannually on January 1 and July 1. The discount in connection with the issue was \)54,000, which is being amortized monthly on a straight-line basis. The bonds are convertible after one year into 8 shares of Volker Inc.’s \(100 par value common stock for each \)1,000 of bonds. On August 1, 2018, $250,000 of bonds were turned in for conversion into common stock. Interest has been accrued monthly and paid as due. At the time of conversion, any accrued interest on bonds being converted is paid in cash.
Instructions
Prepare the journal entries to record the conversion, amortization, and interest in connection with the bonds as of the following
dates. (Round to the nearest dollar.)
(a) August 1, 2018. (Assume the book value method is used.)
(b) August 31, 2018.
(c) December 31, 2018, including closing entries for end-of-year.
CA16-2 ETHICS (Ethical Issues—Compensation Plan) The executive officers of Rouse Corporation have a performance-based compensation plan. The performance criteria of this plan is linked to growth in earnings per share. When annual EPS growth is 12%, the Rouse executives earn 100% of the shares; if growth is 16%, they earn 125%. If EPS growth is lower than 8%, the executives receive no additional compensation.
In 2014, Joan Devers, the controller of Rouse, reviews year-end estimates of bad debt expense and warranty expense. She calculates the EPS growth at 15%. Kurt Adkins, a member of the executive group, remarks over lunch one day that the estimate of bad debt expense might be decreased, increasing EPS growth to 16.1%. Devers is not sure she should do this because she believes that the current estimate of bad debts is sound. On the other hand, she recognizes that a great deal of subjectivity is involved in the computation.
Instructions
Answer the following questions.
(a) What, if any, is the ethical dilemma for Devers?
(b) Should Devers’s knowledge of the compensation plan be a factor that influences her estimate?
(c) How should Devers respond to Adkins’s request?
(Issuance and Conversion of Bonds) For each of the unrelated transactions described below, present the entry(ies) required to record each transaction.
1. Grand Corp. issued \(20,000,000 par value 10% convertible bonds at 99. If the bonds had not been convertible, the company’s investment banker estimates they would have been sold at 95.
2. Hoosier Company issued \)20,000,000 par value 10% bonds at 98. One detachable stock purchase warrant was issued with each \(100 par value bond. At the time of issuance, the warrants were selling for \)4.
3. Suppose Sepracor, Inc. called its convertible debt in 2017. Assume the following related to the transaction. The 11%, \(10,000,000 par value bonds were converted into 1,000,000 shares of \)1 par value common stock on July 1, 2017. On July 1, there was \(55,000 of unamortized discount applicable to the bonds, and the company paid an additional \)75,000 to the bondholders to induce conversion of all the bonds. The company records the conversion using the book value method.
(Issuance, Exercise, and Termination of Stock Options) On January 1, 2018, Titania Inc. granted stock options to officers and key employees for the purchase of 20,000 shares of the company’s \(10 par common stock at \)25 per share. The options were exercisable within a 5-year period beginning January 1, 2020, by grantees still in the employ of the company, and expiring December 31, 2024. The service period for this award is 2 years. Assume that the fair value option-pricing model determines total compensation expense to be \(350,000.On April 1, 2019, 2,000 options were terminated when the employees resigned from the company. The market price of the common stock was \)35 per share on this date.On March 31, 2020, 12,000 options were exercised when the market price of the common stock was $40 per share.
Instructions
Prepare journal entries to record issuance of the stock options, termination of the stock options, exercise of the stock options, and charges to compensation expense, for the years ended December 31, 2018, 2019, and 2020.
(Warrants Issued with Bonds and Convertible Bonds) Incurring long-term debt with an arrangement whereby lenders receive an option to buy common stock during all or a portion of the time the debt is outstanding is a frequent corporate financing practice. In some situations, the result is achieved through the issuance of convertible bonds; in others, the debt instruments and the warrants to buy stock are separate.
Instructions
(a) (1) Describe the differences that exist in current accounting for original proceeds of the issuance of convertible bonds and of debt instruments with separate warrants to purchase common stock.
(2) Discuss the underlying rationale for the differences described in (a)(1) above.
(3) Summarize the arguments that have been presented in favor of accounting for convertible bonds in the same manner as accounting for debt with separate warrants.
(b) At the start of the year, Huish Company issued \(18,000,000 of 12% bonds along with detachable warrants to buy 1,200,000 shares of its \)10 par value common stock at \(18 per share. The bonds mature over the next 10 years, starting one year from date of issuance, with annual maturities of \)1,800,000. At the time, Huish had 9,600,000 shares of common stock outstanding. The company received $20,040,000 for the bonds and the warrants. For Huish Company, 12% was a relatively low borrowing rate. If offered alone, at this time, the bonds would have sold in the market at a 22% discount. Prepare the journal entry (or entries) for the issuance of the bonds and warrants for the cash consideration received.
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