QUESTION 4:

On 1 July 2022 Supertubes Ltd issues $50 million of convertible bonds to Magnatubes

Ltd. The bonds have a life of three years, a face value of $10.00 each, and they offer

interest, payable at the end of each financial year, at a rate of 8 per cent per annum. The

bonds are issued at their face value and each bond can be converted into two ordinary

shares in Supertubes Ltd at any time in the next three years. Organisations of a similar risk

profile have recently issued debt with similar terms, but without the option for conversion.

The market requires a rate of return of 10 per cent per annum on such securities. It is

considered that investors in Supertubes Ltd are prepared to take a lower return (8 per cent)

as a result of the facility to convert the bonds to equity.

REQUIRED

Provide the journal entries to account for:

a) the issue of the above securities

b) the payment of the first year's interest, and

c) the conversion of the securities to equity, assuming that the conversion takes

place two years after the bonds are issued.

QUESTION 5:

Tea Tree Ltd has acquired some government bonds on 1 July 2022. The government bonds

will generate contractual cash flows that are solely principal and interest. The cash flows

comprise:

a return of the principal amount of $2 000 000 in five years' time, and

payments of interest of $200 000 at the end of each of the next five years.

The government bonds were acquired at a price that will generate an effective interest rate of

6 per cent. That is, they were sold when the market required a rate of return of 6 per cent on

government bonds with these cash flow characteristics. The required market rate of return for

these government bonds decreased to 5 per cent on 30 June 2023 (which caused the fair value

of the bonds to rise). Tax implications will be ignored for the purposes of answering this

question.

REQUIRED

a) Determine the initial purchase price of the government bonds on 1 July 2022.

b) Provide the accounting journal entries for the government bonds for the years

ending 30 June 2023 and 30 June 2024, assuming that the business model being

used for the asset focuses upon collecting the contractual cash flows.

c) Provide the accounting entries for the government bonds for the year ending 30

June 2023, assuming that the business model being used has the objective of both

collecting the contractual cash flows from the government bonds as well as selling

government bonds.

d) Provide the accounting entries for the government bonds for the year ending 30

June 2023, assuming that the business model being used for government bonds

focuses upon trading government bonds