Is There a Loss on Conversion?
Holton Co. recently issued $1,000,000 face value, 8%, 30 year debentures at 97. The debentures are callable at 103 upon 30 days’ notice by the issuer at any time beginning five years after the date of issue. The debentures are convertible into $1 par value common stock of the company at the conversion price of $12.50 per share for each $500 or multiple thereof of the principal amount of the debentures ($500/$12.50 = 40 shares for each $500 of face value). Assume that no value is assigned to the conversion feature at the date of issue of the debentures. Assume further that five years after issue, debentures with a face value of $100,000 and book value of $97,500 are tendered for conversion on an interest payment date when the market price of the debentures is 104 and the common stock is selling at $14 per share. J. K. Biggs, the company accountant, records the conversion as follows:
|
Bonds Payable |
100,000 |
|
|
Discount on Bonds Payable |
|
2,500 |
|
Common Stock |
|
8,000 |
|
Paid In Capital in Excess of Par |
|
89,500 |
Julie Robinson, staff auditor for the company’s CPA firm, reviews the transaction and feels the conversion entry should reflect the market value of the stock. According to Robinson’s analysis, a loss on the bond conversion of $14,500 should be recognized. Biggs objects to recognizing a loss, so Robinson discusses the problem with the audit manager, K. Ashworth. Ashworth has a different view and recommends using the market value of the debentures as a basis for recording the conversion and recognizing a loss of only $6,500. Evaluate the various positions. Include in your evaluation the substitute entries that would be made under both Robinson’s and Ashworth’s proposals.