Crane Inc., a publicly accountable enterprise that reports in accordance with IFRS, issued convertible bonds for the
Question:
Crane Inc., a publicly accountable enterprise that reports in accordance with IFRS, issued convertible bonds for the first time on January 1, 2020. The $1 million of six-year, 10% (payable annually on December 31, starting December 31, 2020), convertible bonds were issued at 109, yielding 9%. The bonds would have been issued at 99 without a conversion feature, and yielding a higher rate of return. The bonds are convertible at the investor’s option.
The company’s bookkeeper recorded the bonds at 109 and, based on the $1,090,000 bond carrying value, recorded interest expense using the effective interest method for 2020. He prepared the following amortization table:
| Cash Interest | Effective Interest | Premium | Carrying Amount | ||||||||
| Date | (10%) | (9%) | Amortization | of Bonds | |||||||
| Jan. 1, | 2020 | $1,090,000 | |||||||||
| Dec. 31, | 2020 | $100,000 | $98,100 | $1,900 | 1,088,100 | ||||||
You were hired as an accountant to replace the bookkeeper in November 2018. It is now December 31, 2018, the company’s year end, and the CEO is concerned that the company’s debt covenant may be breached. The debt covenant requires Crane to maintain a maximum debt to equity ratio of 2.3. Based on the current financial statements, the debt-to-equity ratio would be 2.6. The CEO recalls hearing that convertible bonds should be reported by separating out the liability and equity components, yet he does not see any equity amounts related to the bonds on the current financial statements. He has asked you to look into the bond transactions recorded and make any necessary adjustments. He would also like you to explain how any adjustments that you make affect the debt to equity ratio.
Determine the amount that should have been reported in the equity section of the statement of financial position at January 1, 2020, for the conversion right, considering that the company must comply with IFRS.
Prepare the journal entry that should have been recorded on January 1, 2020
Using a financial calculator or computer spreadsheet functions, calculate the effective rate (yield rate) for the bonds.
Prepare a bond amortization schedule from January 1, 2020, to December 31, 2021, using the effective interest method and the corrected value for the bonds. (Round answers to 0 decimal places, e.g. 5,275.)
Prepare the journal entry dated January 1, 2018 to correct the bookkeeper’s recording errors in 2020. Ignore income tax effects.
Prepare the journal entry at December 31, 2018 for the interest payment on the bonds.
Expert Answer:
