Question

On January 1, 2016, Capital Reserves issued $40 million of 9%, 10-year convertible bonds at 101. The bonds pay interest on June 30 and December 31. Each $1,000 bond is convertible into 40 shares of Capital's no par common stock. Bonds that are similar in all respects, except that they are nonconvertible, currently are selling at 99. Capital applies International Financial Reporting Standards (IFRS). Upon issuance, Capital should:

1) Credit bonds payable $36,600,000.
2) Credit equity $400,000.
3) Credit bonds payable $40,400,000.
4) Credit premium on bonds payable $400,000.

Answer 1

Upon issuance of the convertible bonds at a premium, Capital should credit bonds payable for the face value of $40 million and premium on bonds payable for the extra 1% received, which is $400,000. The correct option is to credit premium on bonds payable $400,000.

Step-by-step explanation:

On January 1, 2016, Capital Reserves issued $40 million of 9%, 10-year convertible bonds at 101. Under IFRS, when a company issues bonds at a premium (above 100%), the credit entry should reflect the actual proceeds from the bond issuance. In this case, the bonds were sold at 101, which means that for every $1,000 of face value, the company received $1,010 ($1,000 * 101%). Therefore, the correct entry for the proceeds is to credit bonds payable at the face value of $40 million, and to credit the premium on bonds payable for the additional 1% received over the face value, which would be $400,000 (1% of $40 million).

Considering each option:

1. Credit bonds payable $36,600,000 is incorrect since it does not match the face value or the issue price.
2. Credit equity $400,000 is incorrect, as the premium on bonds payable is not recorded as equity.
3. Credit bonds payable $40,400,000 is incorrect because this figure would imply a bonds payable credit at over the $40 million face value.
4. Credit premium on bonds payable $400,000 is correct because it reflects the premium received over the face value of the bonds.