Question

On January 1,2019 , when its $30 par value common stock was selling for $80 per share, Swifty Corp. issued $11,100,000 of 8% convertible debentures due in 20 years. The conversion option allowed the holder of each $1,000 bond to convert the bond into five shares of the corporation's common stock. The debentures were issued for $11,988,000. The present value of the bond payments at the time of issuance was $9,435,000, and the corporation believes the difference between the present value and the amount paid is attributable to the conversion feature. On January 1,2020 , the corporation's $30 par value common stock was split 2 for 1 , and the conversion rate for the bonds was adjusted accordingly. On January 1, 2021, when the corporation's $15 par value common stock was selling for $135 per share, holders of 30% of the convertible debentures exercised their conversion options. The corporation uses the straight-line method for amortizing any bond discounts or premiums. (a) Prepare the entry to record the original issuance of the convertible debentures.

Answer 1

Swifty Corp. recorded the issuance of convertible debentures by debiting Cash for $11,988,000 and crediting Bonds Payable for the present value of $9,435,000, with the remainder credited to Premium on Bonds Payable to account for the conversion feature.

Step-by-step explanation:

To record the original issuance of the convertible debentures by Swifty Corp, we first understand that the value paid for the debentures is $11,988,000, while the present value of the payments from the bonds is determined to be $9,435,000. The difference between these amounts, $2,553,000 ($11,988,000 - $9,435,000), is attributed to the conversion feature of the debentures. Given that the bonds were sold at a premium, the journal entry to record the issuance will involve debiting Cash for $11,988,000, crediting Bonds Payable for $9,435,000 (the present value of the bond payments), and crediting Premium on Bonds Payable for $2,553,000 (the premium paid over the present value).

Here is the journal entry on January 1, 2019:

• Debit Cash $11,988,000
• Credit Bonds Payable $9,435,000
• Credit Premium on Bonds Payable $2,553,000

The reason for separating the premium and recording it in a different account is that it represents the value that purchasers are willing to pay for the added benefit of being able to convert the debentures into common stock. The premium will be amortized over the 20-year life of the bonds using the straight-line method. Swifty Corp. will make periodic entries to gradually reduce the Premium on Bonds Payable account and recognize it as interest expense over the life of the debentures.