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# Accounting for Bond Conversions

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E16-6 (Conversion of Bonds) On January 1, 2007, Gottlieb Corporation issued \$4,000,000 of 10-year,
8% convertible debentures at 102. Interest is to be paid semiannually on June 30 and December 31. Each
\$1,000 debenture can be converted into eight shares of Gottlieb Corporation \$100 par value common stock
after December 31, 2008.

On January 1, 2009, \$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, 2009. 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 on a straight-line basis.

Instructions

Make the necessary journal entries for:
(a) December 31, 2008. (c) March 31, 2009.
(b) January 1, 2009. (d) June 30, 2009.
Record the conversions using the book value method.

#### Solution Preview

First, the premium on the bonds issued at January 1, 2007 was \$4,000,000*.02, or \$80,000. It is amortized over 20 semi-annual periods (i.e., twice per year for 10 years) at \$80,000/20, or \$4,000 per period.

(a) December 31, 2008.

12/31/08 Premium on Bonds Payable 4,000 (\$80,000/20)
Interest Expense 156,000
Cash 160,000 (\$4,000,000*.08/2)
To record the bond premium amortization and interest payment on bonds.

(b) January 1, 2009

Because \$400,000 is 10 percent of \$4,000,000 (i.e., \$400,000/\$4,000,000=.10), the premium attributable to the portion being converted is \$80,000*.10, or \$8,000. By now, the company has amortized the premium on all \$4,000,000 of bonds by \$4,000*4 semi-annual periods, or \$16,000. Thus, it has amortized \$16,000*.10, or \$1,600 on the portion being converted. The outstanding premium is \$8,000 - \$1,600, or \$6,400. There is no gain or loss on ...

#### Solution Summary

This solution illustrates, in detail, how to compute the bond premium amortization and loss or gain on conversion of bonds to common stock, as well as the journal entries involved in accruing interest, recording bond conversions, and paying accrued interest.

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