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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 “with-and-without” method to value the compound instrument.

Short Answer

Expert verified

Answer

Correct option: d: use the “with-and-without” 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

CA16-5 (EPS: Preferred Dividends, Options, and Convertible Debt) “Earnings per share” (EPS) is the most featured, single financial statistic about modern corporations. Daily published quotations of stock prices have recently been expanded to include for many securities a “times earnings” figure that is based on EPS. Stock analysts often focus their discussions on the EPS of the corporations they study.

Instructions

(a) Explain how dividends or dividend requirements on any class of preferred stock that may be outstanding affect the computation of EPS.

(b) One of the technical procedures applicable in EPS computations is the “treasury-stock method.” Briefly describe the circumstances under which it might be appropriate to apply the treasury stock method.

(c) Convertible debentures are considered potentially dilutive common shares. Explain how convertible debentures are handled for purposes of EPS computations.

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.

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

Question: Petrenko Corporation has outstanding 2,000 \(1,000 bonds, each convertible into 50 shares of \)10 par value ordinary shares. The bonds are converted on December 31, 2017. The bonds payable has a carrying value of \(1,950,000 and conversion equity of \)20,000. Record the conversion using the book value method.

Briefly explain why corporations issue convertible securities.

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