Financial Accounting: Liabilities & Equities (FA3) Exam Review

FA3 Exam Review notes Barbara Wyntjes, CGA, MBA, B.Sc.
If Zil uses the book value method to record the conversion, what will the journal entry
include?
1) A $90,000 debit to contributed capital, common stock conversion rights
2) A $120,000 debit to contributed capital, common stock conversion rights
3) A loss on bond redemption of $150,000
4) A loss on bond redemption of $180,000
Multiple Choice solutions:
a. 3 [$1,030 / ($1,030 + $50)] $1,040 = $991,850
b. 1 120,000 x .75 = 90,000
Question 3 (18 marks)
Tom’s Tequila Inc. (TT) sold $1,000,000 of 9%, 10-year convertible bonds on January 1,
2002 for proceeds of $960,000. The market was demanding a 10% yield for similar bonds
that did not have a conversion privilege. At the investor’s option, each $1,000 bond is
convertible into 25 common shares until December 31, 2007, and into 30 common shares
from January 1, 2008, until maturity. The bonds are dated January 1, 2002, and pay
interest annually on December 31, maturing December 31, 2011. TT uses the effective
interest method to amortize discounts or premiums, and the book value method for
conversion.
On January 1, 2003, 70% of the bonds were converted. At that time, the common shares
were trading at $55. The rest of the bonds were never converted.
TT is a public company listed on the Toronto Stock Exchange.
Required: Note that the bonds are convertible at the investor’s option.
Prepare journal entries for January 1, 2002; December 31, 2002; January 1, 2003; and
December 31, 2011.
Using factor tables: $ 938,514
Value of conversion rights ($960,000 – $938,514) = $21,486 (Incremental method)
Note: A financial calculator may also be used. Answers determined with the calculator
may vary slightly due to rounding. FV = 1,000,000, n = 10, i = 10, PMT = 90,000, PV =
938,554
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