On August 1, 2021, LOL Corporation issued 15-year, $5,000,000, 8%, convertible bonds for proceeds of $5,325,000. The bonds pay interest annually each July 31. Each $1,000 bond is convertible into 50 common shares at the investor’s option. If the bond had been sold without the conversion feature, it would have sold for $4,240,000, reflecting a market interest rate of 10%. 

LOL’s controller recorded the bond issuance on August 1 as follows:

The controller did not make any other journal entries related to the bonds as of the company’s year-end, December 31. 

LOL closed its general ledger accounts and is now preparing its December 31, 2021, financial statements. Upon reviewing the long-term liabilities, you come across the convertible bond journal entry shown above. You know LOL has debt covenants that specify its debt-to-equity ratio cannot exceed 1.20. The preliminary financial statements show total liabilities to be $25,000,000 and total equity of $20,000,000.

Required: 

a. Prepare the correcting journal entry or entries related to the issuance of the convertible bonds. 

b. Prepare the correcting journal entry or entries for the interest on the convertible bonds. Ignore any tax implications. (Remember that the general ledger accounts have been closed for the year.) 

c. Discuss the effect of any corrections to the bond recording on the debt-to-equity ratio. However, you do not need to recalculate the ratio.

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