Conversion Of Bonds On January 1, 2014, Gottlieb Corporation

Conversion of Bonds on January 1, 2014, Gottlieb Corporation Issue

On January 1, 2014, Gottlieb Corporation issued $4,000,000 of 10-year, 8% convertible debentures at 102. Interest is paid semiannually on June 30 and December 31. Each $1,000 debenture can be converted into eight shares of Gottlieb Corporation's $100 par value common stock after December 31, 2015. On January 1, 2016, $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, 2016. 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 using the effective-interest method. Make the necessary journal entries for: (a) December 31, 2015; (b) January 1, 2016; (c) March 31, 2016; (d) June 30, 2016. Record the conversions using the book value method.

Paper For Above instruction

The accounting for convertible bonds involves recognizing interest expense, amortizing bond premiums or discounts, and recording conversions at book value, which requires understanding bond valuation, amortization techniques, and equity transactions related to conversions. This paper discusses the journal entries for Gottlieb Corporation's bond transactions from issuance through subsequent conversions, emphasizing the principles of accounting for convertible debt using the book value method.

Gottlieb Corporation issued $4,000,000 of debentures at 102, which implies an issuance price of $4,080,000, considering a 102% premium. The bonds carry an 8% interest rate, payable semiannually, meaning interest payments of $160,000 ($4,000,000 x 8%/2) occur every June 30 and December 31. Since bonds were issued above par, the excess over the face amount represents a bond premium, which needs amortization over the bond's life using the effective-interest method, aligning interest expense recognition with the market rate at issuance.

The initial journal entry upon issuance on January 1, 2014, records the cash received, the bonds payable, and the premium. Subsequently, each interest period involves amortizing part of the premium and accruing interest expense based on the effective-interest rate. This approach reflects the true cost of borrowing over time, adjusting the carrying amount of the bonds to their face value at maturity.

The conversion of bonds into equity requires recording the transaction at the book value of bonds payable, offset by the carrying amount of the bonds at the time of conversion. Under the book value method, the issuance costs are ignored, and the bonds are removed from liabilities at their carrying amount, with an entry increasing common stock and additional paid-in capital based on the conversion ratio.

On January 1, 2016, $400,000 of bonds are converted into common stock. The number of shares issued is based on the conversion ratio of 8 shares per $1,000 of bonds. The market price of common stock at this date ($110) does not influence the journal entries under the book value method; the focus is on the bonds' carrying amount. Another $400,000 is converted on March 31, 2016, where the market price is $115; again, the journal entry reflects the book value of bonds payable and equity accounts.

Interest accrued at March 31 (the date of the second conversion) is also recorded, and the interest expense for the period is determined considering the amortized premium and the effective interest rate. The effective-interest method ensures proper matching of interest expense with the period’s economic benefits and costs, providing clarity and accuracy in financial statements.

In summary, the journal entries involve:

  • Issuance of bonds (2014)
  • Interest expense accruals and premium amortization (semiannual)
  • Conversion entries at book value (January 1 and March 31, 2016)
  • Interest accrual at March 31, 2016

Applying these principles ensures compliance with accounting standards such as US GAAP and IFRS, providing transparent and comparable financial information for investors and stakeholders.

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