Company A issues 2000 convertible notes on 1 July 2012. The notes have a 3-year term and are issued at par with a face value of K1000 per note, giving total proceed at the date of issue of K2, 000 000. Notes pay interest at 6% annually in arrears. The holder of each note is entitled to convert the note into 250 ordinary shares of Company A at any time up to maturity. When the notes are issued, the prevailing market rate for similar debt (similar term, similar credit status of issuer and similar cash flows) without conversion options is 9%. This rate is higher than the convertible note's rate because the holder of the convertible note is prepared to accept a lower of interest rate given the implicit value of its conversion option. The issuer calculates the contractual cash flows using the market interest rate (9%) to work out the value of holder's option, as follows

Present value of the principal: K2 000 000 payable in 3 years' time Present value of the interest: K120 000 (K2 000 000 x 6%) payable annually In areas for 3 years Total Liability component Equity Component (by deduction) Proceeds of the not issue

K1 544 367 303 755 K1 848 122 151 878 K2 000 000

Required Prepare the journal entries to account for this transaction for each year of its term under each of the following circumstances. (a) The holders exercise their conversion option at the expiration of the note's term. (b) The holders do not exercise their option and the note is repaid at the end of its term. (c) The holders exercise their option at the end of year 2

Answer rating: 100% (QA)

ANSWER Lets go through each scenario and prepare the journal entries accordingly Scenario a Holders ... View the full answer