Accounting for convertible securities*

Suizo-Hispania, a designer and builder of luxury automobiles, issues at par 15 million of 3% ten-year convertible bonds at the start of year 7. (All currency amounts are in euros.) Holders can convert each 1,000 bond into 250 Suizo-Hispania ordinary shares (of 1 par value) from year 9. The company would have had to offer investors an 8% yield if it had issued debt without the conversion option.

Required

(a) How does Suizo-Hispania (S-H) record the issue of bonds in year 7, assuming:

(i) it accounts for them as debt only?

(ii) it recognises the equity component of the securities separately?

Use journal entries or the balance sheet equation. Ignore issuance costs. Assume the residual value approach is used to measure the equity component of the securities.

(b) What is the interest expense Suizo-Hispania records in year 7 under assumption

(a) (i)? under assumption

(a) (ii)? The company has a calendar financial year and a full year’s interest is charged in year 7. The company uses the interest method to determine interest expense under

(a) (ii).

(c) Bondholders convert all the bonds to ordinary shares at the start of year 9. The market price of an ordinary S-H share then is 5. How does S-H record the issue of ordinary shares in exchange for bonds, assuming that on issue of the bonds in year 7:

CHAPTER 12 • SHAREHOLDERS’ EQUITY 389 390 PART 2 • THE HOUSE OF ACCOUNTING

(i) it accounts for them as debt?

(ii) it recognises the equity component of the securities separately?

Check figure:

(a) (ii) Equity component 5.03 million

* Assignment draws on material in section 2 of this chapter.

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