Early Extinguishment and Conversion of Bonds
On January 1, 2007, Brewster Company issued 2,000 of its 5 year, $1,000 face value, 11% bonds dated January 1 at an effective annual interest rate (yield) of 9%. Interest is payable each December 31. Brewster uses the effective interest method of amortization. On December 31, 2008, the 2,000 bonds were extinguished early through acquisition in the open market by Brewster for $1,980,000 plus accrued interest. On July 1, 2007, Brewster issued 5,000 of its 6 year, $1,000 face value, 10% convertible bonds dated July 1 at an effective annual interest rate (yield) of 12%. Interest is payable every June 30 and December 31. The bonds are convertible at the investor’s option into Brewster’s common stock at a ratio of 10 shares of common stock for each bond. On July 1, 2008, an investor in Brewster’s convertible bonds tendered 1,500 bonds for conversion into 15,000 shares of Brewster’s common stock, which had a fair market value of $105 and a par value of $1 at the date of conversion.
Instructions:
1. Make all necessary journal entries for the issuer and the investor to record the issuance of both the 11% and the 10% bonds. Ignore any potential impact of year to year market value changes on the investor accounting for the bonds.
2. Make all necessary journal entries to record the early extinguishment of both debt instruments assuming:
(a) Brewster considered the conversion to be a significant culminating event, and the investors considered their investment in convertible bonds to be debt rather than equity.
(b) Brewster considered the conversion to be a no culminating event, and the investors considered their investment in convertible bonds to be equity rather than debt.