On September 30, 2011, Gargiola Inc. issued $4 million of 10-year, 8%, convertible bonds for $4.6 million. The bonds pay interest on March 31 and September 30 and mature on September 30, 2021. Each $1,000 bond can be converted into 80 no par value common shares. In addition, each bond included 20 detachable warrants. Each warrant can be used to purchase one common share at an exercise price of $15. Immediately after the bond issuance, the warrants traded at $3 each. Without the warrants and the conversion rights, the bonds would have been expected to sell for $4.3 million. The proceeds from the issuance of the bonds with conversion rights and with the detachable warrants included the following:
Gross proceeds ......... $4,700,000
Underwriting fees ....... 100,000
Net proceeds .......... $4,600,000
Gargiola Inc. adopted the policy of capitalizing and amortizing the underwriting fees with the bonds’ premium, which is accounted for using the effective interest method.
On March 23, 2014, half of the warrants were exercised. The common shares of Gargiola Inc. were trading at $20 each on this day.
Immediately after the payment of interest on the bonds, on September 30, 2016, all bonds outstanding were converted into common shares. Assume the entity follows IFRS.
(a) Prepare the journal entry to record the issuance of the bonds on September 30, 2011.
(b) Using a financial calculator or computer spreadsheet functions, calculate the effective rate (yield rate) for the bonds. Leave at least four decimal places in your calculation.
(c) Prepare a bond amortization schedule from September 30, 2011, to September 30, 2016, using the effective interest rate.
(d) Prepare the December 31, 2011 year-end adjusting journal entries and the payment of interest on March 31, 2012. Assume that Gargiola Inc. does not use reversing entries.
(e) Prepare the journal entry to account for the exercise of the warrants on March 30, 2014. How many common shares were issued in this transaction?
(f) Prepare the journal entry to account for the bond redemption on September 30, 2016.
(g) How many shares were issued on September 30, 2016? What do you believe was the likely market value of the common shares as of the date of the conversion, September 30, 2016?