On January 1, 2020, a company issues convertible notes. The total principal of the issuance is $20,000,000, each note has a denomination of $1,000 (i.e., there are 20,000 notes each with a $1,000 denomination), the coupon interest is 1.5% per annum payable annually (i.e., on December 31), and the notes mature in 5 years. There is an issuer call option any time after the end of the first year at the principal or par amount of $1,000, plus accrued and unpaid interest. Each $1,000 note is convertible into 50 shares of $1 par value common stock at maturity (i.e., the strike price is $20/share). Additionally, the notes may be early converted in any quarter following a quarter in which the companys stock traded at or above $50 for at least 45 days, or if the company calls the notes. The companys stock price is $16/share at the date of issuance.

The fair value of the convertible notes totaled $20,000,000 at issuance and therefore the company received gross proceeds from the issuance of $20,000,000 in cash (i.e., the notes were issued at par). At inception, the fair value of a nonconvertible debt issuance with the same terms issued by companies with a similar credit quality is $19,000,000, and the fair value of a freestanding call option on the same number of common shares and a strike price of $20/share is $2,000,000. At the end of the first year, the fair value of the conversion option has risen to $3,500,000.

Assume the conversion option does not require bifurcation as an embedded derivative, because it qualifies for the own equity scope exception, and the conventional convertible debt model should be applied for accounting purposes.

a. Please record the issuance of the notes.

b. The company incurred issuance costs totaling $600,000, which were paid in cash. Please record the payment of the issuance costs.

c. Assume any discount is amortized using the straight-line method over the 5-year expected life of the notes. Please record the first years interest expense.

d. If the average stock price was $22/share for the year and the stock price at the end of the first year was $19 share, how many shares (rounded to the nearest 1,000 shares) would be added to the denominator in the diluted EPS computation for the first year (assuming the convertible notes are dilutive)?

e. Assuming the convertible notes were dilutive, what is the amount of the adjustment to the numerator in the diluted EPS computation for the first year? Please assume the tax rate is 40%.

f. Assume at the end of the first year, the company calls the convertible notes and the holders do not exercise their right to convert (i.e., the stock price is at $19/share and the strike price is $20/share so exercise is uneconomical). Please record the extinguishment of the convertible notes.

g. Assume instead that at the end of the first year, the stock price is at $23/share. Therefore when the company calls the convertible notes, the holders exercise their right to convert (i.e.., the holders may avoid the call by immediately converting, and it is economical to convert because the strike price is $20/share and the current stock price is $23/share). Please record the conversion of the convertible notes.

h. Assume instead that the notes are converted at maturity in accordance with the stated conversion rights when the companys stock price is at $35/share. Also assume all entries to accrue and pay interest due at maturity have been made. Please record the conversion of the convertible notes.