On January 1, 2011, Gottlieb Corporation issued $6 million of 10-year, 7%, convertible debentures at 104. Investment bankers believe that the debenture would have sold at 102 without the conversion privilege. Interest is to be paid semi-annually on June 30 and December 31. Each $1,000 debenture can be converted into five common shares of Gottlieb Corporation after December 31, 2012. On January 1, 2013, $400,000 of debentures are converted into common shares, which are then selling at $110. An additional $400,000 of debentures are converted on March 31, 2013. The common shares’ market price 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
(a) Make the necessary journal entries for:
1. December 31, 2012
2. January 1, 2013
3. March 31, 2013
4. June 30, 2013
Record the conversions using the book value method.
(b) From the perspective of the debenture holders, why would they be motivated to wait for the conversion of the bonds into common shares? What are the risks involved in waiting and what could the bondholders ultimately give up by waiting too long?