On January 1, 2012, when its $30 par-value common stock was selling for $80 per share, Gierach Corporation issued $10 million of 4% convertible debentures due in 10 years. The conversion option allowed the holder of each $1,000 bond to convert the bond into five shares of the company’s $30 par-value common stock. Cash settlement upon conversion is not permitted. The debentures were issued for $10 million. Without the conversion feature, the bonds would have been issued for $8.5 million.
On January 1, 2014, the company’s $30 par-value common stock was split three for one.
On January 1, 2015, when the company’s $10 par-value common stock was selling for $90 per share, holders of 40% of the convertible debentures exercised their conversion options.
1. Following U.S. GAAP, prepare a journal entry to record the original issuance of the convertible debentures.
2. How much interest expense would the company recognize on the convertible debentures in 2012?
3. Prepare a journal entry to record the exercise of the conversion option.
4. Why do many companies use the book value method to record debt conversions?