On January 1, 2018, CT Ltd issued $20 million convertible bonds. The bonds have a life of three years and are issued at 21 million with a face value of $100 per bond. The bonds pay an interest of 6% annually in arrears. The holder of each bond is entitled to convert the bond into 25 ordinary shares of CT Ltd at any time up to maturity.

Companies of a similar risk profile have recently issued debt with similar terms, but without the option of conversion, and the market required a rate of return of 10% per annum on such securities. It is considered that investors in CT Ltd’s convertible bonds are preparing to take a lower return as a result of the facility to convert the bonds to shares.

On January 1, 2020, $5,000,000 of the convertible bonds are converted to ordinary shares of CT Ltd. The remaining bonds are redeemed on the maturity date.

Instead of issuing new shares upon conversion, CT Ltd satisfies the requirement for equity shares to be delivered to the bondholders through the use of treasury shares. On December 31, 2018, CT Ltd. reacquired 2,000,000 of its ordinary shares at a price of $4 per share.

 

 

1.     Discuss the classifications of the convertible bonds issued on January 1, 2018. Give reasons for your answer.  

2.     Provide the journal entries to account for: 

(a) The issue of the above securities;

(b) The payment of the first year’s interest;

(c) The reacquiring of the treasury shares;

(d) The conversion of the securities to ordinary shares. Rather than issuing new ordinary shares, CT will deliver to bondholders of its own shares that it had previously repurchased and held as treasury shares;

(e) The interest payment and redemption of the bonds at the end of 2020; and

(f) The remaining treasury shares which were reacquired on December 31, 2018, was reissued at a price of $6 per share on December 31, 2020.