Ch. 15 Notes

prompt conversion sweetner

Accounting for Convertible Debt Induced Conversion • Issuer wishes to encourage ____ ____. • Issuer offers additional consideration, called a"______." • ____ is an expense of the current period.

the bond and stock warrants must be sold together

Chen Company issues 10 bonds with a total par value of $10,000 and detachable stock warrants, which provide the right to buy 500 shares of Chen stock over thenext 5 years at $20 per share (the $20 is often referred toas the strike price). What are the alternatives that you, the investor, have related to these detachable stock warrants?

book value

Companies use the ___ __ method when converting bonds.

interest costs capital structure

Convertible debt are bonds (or notes) that have the added feature of being able to convert into common stock during a specified period. Why have some companies recently issued bonds as this method of financing? • To lower _____ ____. Generally, convertible debt offers a lower interest rate to investors because investors place a value on the conversion feature. • To manage ___ ___. Issuers often have a call feature attached to the convertible debt. This feature enables the issuer to have some control over its capital structure

debit Debt Conversion Expense 80,000 debit Bonds Payable 1,000,000 credit Common Stock (100,000 × $1) 100,000 credit Paid-in Capital in Excess of Par—Common Stock 900,000 credit Cash 80,000

Graze, Inc. has outstanding $1,000,000 par value convertible bonds convertible into 100,000 shares of $1 par value common stock. Graze wishes to reduce its annual interest cost. To do so, Graze agrees to pay the holders of itsconvertible bonds an additional $80,000 if they will convert. Assuming conversion occurs, how should Graze record this transaction?

debit cash 51,000 (1,000 x 1.02 x 50) credit bonds payable 50,000 (1,000 x 50) credit premium on bonds payable 1,000 (.02 x 50,000)

Lindor Company issues 50 convertible bonds with a 5-year life with a par value of $1,000 each to Hernandez Inc. The bonds sold at 102. Each bond is convertible into 40 shares of Lindor's $1 par value common stock. The fair value of Lindor's equity component at date of issuance is $200 for each bond. What entry would Lindor make to record the issuance of the convertible debt?

debit bonds payable 50,000 debit premium on bonds payable 580 credit common stock 2,000 (50 x 40 x $1) credit paid-in capital in excess of par - common stock 48,580

Lindor Company issues 50 convertible bonds with a 5-year life with a par value of $1,000 each to Hernandez Inc. The bonds sold at 102. Each bond is convertible into 40 shares of Lindor's $1 par value common stock. The fair value of Lindor's equity component at date of issuance is $200 for each bond. Hernandez decides to convert its 50 convertible bonds into common stock at the end of the second year. At that time,the remaining premium on the convertible bonds is $580. In addition, at the time ofconversion, the fair value of Lindor's common stock is now $1,300 per share. How should Lindor record the conversion?

debit Convertible Preferred Stock (1,000 × $1) 1,000 debit Paid-in Capital in Excess of Par—Preferred Stock (1,000 × $3) 3,000 credit Common Stock (1,000 × $2) 2,000 credit Paid-In Capital in Excess of Par—Common Stock 2,000

Middleton Enterprises issued 1,000 shares of common stock (par value $2) upon conversion of 1,000 shares of preferred stock (par value $1) that was originally issued at $4 per share. The current market value of the common stock is $5 per share. How would Middleton record this transaction?

proportional method

The ____ ____ allocates the proceeds using the proportion of the two amounts, based on fairvalues.

nondetachable warrants

Warrants can only be sold with the bonds

detachable warrants

Warrants may be sold separately from the bonds.

upon conversion

When the debt holder converts the debt to equity, the issuing company recognizes no gain or loss ____ ____.

equity gain principal interest protection

Why would an investor be interested in convertible debt? •___ ____. In a rising stock market, convertible investors may participate in the capital appreciation .• ____ & ____ ____. Convertibles provide protection when the stock market is declining because the convertible can provide interest income and principal recovery.

convertible preferred stock

_____ ____ ____ includes an option for theholder to convert preferred shares into a fixed numberof common shares

nondetachable warrants

_____ _____ do not require an allocation ofthe proceeds between the bonds and the warrants.

warrants

_____ are a security that gives investors the optionto purchase a company's stock at a specific price overa specific period. _____ are typically included as a"sweetener" to investors to purchase a company'sbond issuance. (both blanks are the same word)

stock right

existing stockholders have the right (preemptive privilege) to purchase newly issuedshares in proportion to their holdings.

stock option

gives key employees option topurchase common stock at a given price overextended period of time.

value of convertible bond

value of debt component + value of equity component =

proprotional

which method Determine: 1. value of the bonds without the warrants, and 2. value of the warrants.