Question

Sunland Inc., a publicly accountable enterprise that reports in accordance with IFRS, issued convertible bonds for the first time on January 1, 2020. The $1 million of six-year, 10% (payable annually on December 31, starting December 31, 2020), convertible bonds were issued at 107. The bonds would have been issued at 97 without a conversion feature, and yielded a higher rate of return. The bonds are convertible at the investor’s option.

The company's bookkeeper recorded the bonds at 107 and, based on the $1.070.000 bond carrying value, recorded interest expense using the effective interest method for 2020. He prepared the following amortization table believing that the yield was 796: Cash Interest (10%) Effective Interest (7%) Premium Amortization Date Jan. 1. Dec. 31. Carrying Amount of Bonds $1,070,000 1,044.900 2020 2020 $100,000 $74.900 $25,100 You were hired as an accountant to replace the bookkeeper in November 2021. It is now December 31, 2021, the company's year end, and the CEO is concerned that the company's debt covenant may be breached. The debt covenant requires Sunland to maintain a maximum debt to equity ratio of 2.3. Based on the current financial statements, the debt to equity ratio would be 2.6. The CEO recalls hearing that convertible bonds should be reported by separating out the liability and equity components, yet he does not see any equity amounts related to the bonds on the current financial statements. He has asked you to look into the bond transactions recorded and make any necessary adjustments. He would also like you to explain how any adjustments that you make affect the debt to equity ratio.

Answer 1

Date Account Title Debit Credit 1-Jan-20 Cash 1,070,000 (1000,000 X 1.07) Bonds Payable 970,000 (1000,000 X 0.97) Convertion rights 100,000 Residual method is applicable Under IFRS, the debt component is measured first, with the residual value assigned to equity since it is a residual item. PV 970000 ? 10.703% I N PMT FV Type 6 100000 1000000 Function Arguments ? X RATE Niper 6 t - -100000 PV 970000 + - 970000 - 1000000 1 - 1000000 Type o = 0.107030746 Returns the interest rate per period of a loan or an investment. For example, use 8/4 for quarterly payments at 6% APR Type is a logical value payment at the beginning of the period - 1 payment at the end of the period or omitted. Formula result = 0.107030746 Help on this function OK Cancel Effective Interest Carrying Amount Date Cash Paid Discount 1-Jan-20 31-Dec-20 31-Dec-21) 31-Dec-22 31-Dec-23 31-Dec-25 100000 100000 100000 103820 104229 104681 1051821 105737 106351 3820 4229 4681 5182 5737 6351 970000 973820 9780491 982730 987912 993649 1000000 100000 100000 100000 1-Jan-21 Date Credit Account title Retained Earnings Bond Payable Convertion rights Debit 28,920 71,080 (103820-74900) (1044000-973820) 100,000 Credit 31-Dec-21 Date Account title Interst Expenses Bons Payable Cash Debit 104,229 4,229 100,000