Malibu Ltd issues $10 million of convertible bonds on 1 July 2022. The bonds have a life of four years and they offer interest, payable at the end of each financial year, at a rate of 7 per cent per annum. The bonds are issued at their face value and each bond can be converted into one ordinary share in Malibu Ltd at any time in the next four years. Organisations of a similar risk profile have recently issued debt with similar terms, without the option for conversion, at a rate of 9 percent per annum.

REQUIRED

a. Identify the present value of the bonds and, allocating the difference between the present value and the issue price to the equity component, provide the appropriate accounting entries.

b. Calculate the stream of interest expenses across the four years of the life of the bonds. Provide the accounting entries if the holders of the bonds elect to convert the bonds to ordinary shares at the end of the third year of the bonds