Question

Part A (14 marks)

Company A issues 2000 convertible notes on 1 July 2012. The notes have a three-year term and are issued at par with a face value of $1000 per note, giving total proceeds at the date of issue of $2 million. The notes pay interest at 6% annually in arrears. The holder of each note is entitled to convert the note into 250 ordinary shares of Company A at any time up to maturity. When the notes are issued, the prevailing market interest rate for similar debt (similar term, credit status of issuer and cashflows) without conversion option is 9%. This rate is higher than the convertible note’s rate because the holder of the convertible note is prepared to accept a lower interest rate given the implicit value of its conversion option.

Required: [use the space provided below] Prepare journal entries for each of the following –

1. (a) Recording the issue of the securities on 1 July 2012.

2. (b) Recognise the interest payment for 3 years.

Part B (7 marks)

On 1 March 2010 Lima Ltd enters into a binding agreement with a New Zealand company, which requires the New Zealand company to construct an item of machinery for Lima Ltd. The cost of the machinery is NZ$1 500 000. The machinery is completed on 1 June 2010 and shipped FOB Auckland on that date. The debt is unpaid at 30 June 2010, which is also Lima Ltd’s balance date.

The exchange rates at the relevant dates are:

1 March 2010 1 June 2010 30 June 2010

A$1.00 = NZ$1.20 A$1.00 = NZ$1.30 A$1.00 = NZ$1.25

Required: [use the space provided below]
Provide the required journal entries of Lima Ltd for the year ended 30 June 2010.

Part C (4 marks)

On 5 June 2014 Perth Ltd purchased goods on credit from a supplier in UK. The goods are shipped FOB UK on that date. The cost of the goods is UK£250 000. The debt remains unpaid at 30 June 2014, which is also Perth Ltd’s reporting date.

The exchange rates at the relevant dates are:

5 June 2014	A$1.00 = UK£0.46
30 June 2014	A$1.00 = UK£0.44

Required: [use the space provided below]
Provide the required journal entries of Perth Ltd to account for the above purchase transaction for the

year ended 30 June 2014. Show your calculations/workings.

Answer 1

Part A

In this case, the liability is measured as the present value of the annual coupon payments [$20,000,000 x 6% = $120000] and principal repayment [2,000 x $1,000 = $2,000,000] in three years’ time:

$2,000,000 x 1/(1.10)³ = $1,502,630

$120,000 x 1-1/(1.10)³ = $ 29,842

Present value of liability = $1,502,630 + $ 29,842 = $ 1,532,472

Proceeds to note = $2,000,000

Value of equity component = $2,000,000 - $ 1,532,472 = $ 467,528

Journal Entries

1. Cash at bank Dr. 2,000,000

Convertible note liability Cr. $ 1,532,472

Convertible note option Cr. $ 467,528

2. Interest expense Dr. 153,247

Cash Cr. 120000

Convertible note liability 33,247

(Interest expense at the end of year 1)

Interest expense Dr. 153,247

Cash Cr. 120000

Convertible note liability 33,247

(Interest expense at the end of year 2)

Interest expense Dr. 153,247

Cash Cr. 120000

Convertible note liability 33,247

(Interest expense at the end of year 3)