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Below is a question I got on the Wiley Test Bank:
PVB-0065
Simms Corporation reports under IFRS. Simms issued 2,000 $1,000 convertible bonds at par, with an annual interest rate of 5% when the market was 8%. The bonds are due in 5 years and each $1,000 bond is convertible into 3 shares of common stock. At what amount would Simms record teh liability component of the bond?
a. 239,569
b. 2,006,000
c. 2,000,000
d. 1,760,431
I selected D because I knew it had to be at a discount because of the coupon rate v. market rate even thought I didn’t know how to calculate the answer.
Wiley Explanation:
This answer is correct. Under IFRS, convertible debt must be separated into its debt and equity components. To do this, discount the bond at market interest rates as in US GAAP. The liability component is the discounted amount and the equity component is the residual of the cash received less the discounted amount. Calculations are as follows:
Face amount of the bonds: 2,000 × $1,000 = $2,000,000
Present value of $1 for the principal ($2,000,000 × 0.68058) = $ 1,361,160
Present value of an ordinary annuity for the interest ($100,000 × 3.99271) = $ 399,271
Value of the liability = $ 1,760,431
Value of the equity ($2,000,000 – $1,760,431) = $ 239,569
Journal entry at issuance:
Cash $2,000,000
Bonds Payable $1,760,431
Equity – conversion option $239,569
My concern is how in the world would I calculate the actual amount with out the present value multipliers given to me? I would hate to thing this is an actual possibility on the exam. Especially if the answer choices were closer together in value.
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