Question

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

Answer

Correct option: d: use the “with-and-without” method to value the compound instrument.

Step-by-step solution

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.

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.