On January 1, 2006 when its \($30\) par-value common stock was selling for \($80\) per share, Gierach Corporation issued \($10\) million of 4% convertible debentures due in 10 years. The conversion option allowed the holder of each \($1,000\) bond to convert the bond into five shares of the company’s \($30\) par-value common stock. The debentures were issued for \($10\) million.
Without the conversion feature, the bonds would have been issued for \($8.5\) million.
On January 1, 2008, the company’s \($30\) par-value common stock was split three for one. On January 1, 2009 when the company’s \($10\) par-value common stock was selling for \($90\) per share, holders of 40% of the convertible debentures exercised their conversion options.
Required:
1. Prepare a journal entry to record the original issuance of the convertible debentures.
2. How much interest expense would the company recognize on the convertible debentures in 2006?
3. Prepare a journal entry to record the exercise of the conversion option.
4, Why do many companies use the book value method to record debt conversions?