Exercise 14–27
Requirement 1
Under U.S. GAAP, the entire issue price of convertible debt is recorded as debt:
Under IFRS, convertible debt is divided into its liability and equity elements. We
achieve separation by measuring the fair value of a similar liability that does not
have an associated equity component. In the exercise, we know that bonds similar
in all respects, except that they are nonconvertible, currently are selling at 99 (99%
of face amount), so the liability-first separation gives us the following entry:
is combined with the face amount, and the net amount is recorded as bonds payable.
This is the “net method.” By the gross method, the entry would be:
Equity—conversion option (to balance)…………………………
Exercise 14–27 (concluded)
Requirement 2
* When the net method is used, the discount (or premium) is amortized directly to
the bonds account.
Requirement 3
Common stock (to balance)………………………………..
Amortization for 5 periods (2 1/2 years)
Exercise 14–28
Requirement 1
($ in millions)
Limbaugh (Issuer)
Cash (104% x $30 million)……………………………………………… 31.2
Interstate (Investor)
Investment in stock warrants ($4.8 million x 20%)……………. 0.96
Requirement 2
($ in millions)
Limbaugh (Issuer)
Interstate (Investor)
Exercise 14–29
Requirement 1
At January 1, 2018, the book value of the bonds was the initial issue price,
June 30, 2018
December 31, 2018
Reducing the discount increases the book value of the bonds:
Comparing the amortized initial amount at December 31, 2018, with the fair value
on that date provides the fair value adjustment balance needed:
Exercise 14–29 (continued)
Because none of the change is due to the change in general interest rates, Federal
can assume that the entire change in fair value is caused by a change in the general
(risk-free) interest rate to be the result of credit risk. Any change in the fair value
caused by a change in the credit risk associated with the securities is reported as
other comprehensive income (OCI) in the statement of comprehensive income.
Credit risk is the risk that the investor in the bonds will not receive the promised
interest and maturity amounts at the times they are due. Federal records the
$10,615,924 as a gain in 2018 as other comprehensive income (OCI):
December 31, 2018
Note: A decrease in the value of an asset is a loss; a decrease in the value of a
liability is a gain.
In the balance sheet, the bonds are reported among long-term liabilities at their
$730,000,000 fair value:
Bonds payable $800,000,000
Exercise 14–29 (continued)
Requirement 2
If the fair value at December 31, 2019, is $736,000,000 a year later, Federal
needs to compare that amount with the amortized initial measurement on that date.
That amount was increased when Federal recorded interest during 2019:
June 30, 2019
December 31, 2019
Cash (5.5% x $800,000,000)………………………………….
Reducing the discount increases the book value of the bonds:
Exercise 14–29 (continued)
Comparing the amortized initial amount at December 31, 2019, with the fair value
on that date provides the fair value adjustment balance needed:
December 31, 2019, book value (amortized initial amount) $741,516,052
the change in general interest rates, Federal can assume that the remaining change
in fair value is the result of credit risk. Any change in the fair value caused by a
change in the credit risk associated with the securities is reported as other
comprehensive income (OCI) in the statement of comprehensive income. Credit
risk is the risk that the investor in the bonds will not receive the promised interest
and maturity amounts at the times they are due. Federal records $2,099,872 as a
loss as OCI in the 2019 statement of comprehensive income:
December 31, 2019
Note: An increase in the value of an asset is a gain; an increase in the
value of a liability is a loss.
Exercise 14–29 (concluded)
In the balance sheet, the bonds are reported among long-term liabilities at their
$736,000,000 fair value:
Bonds payable $800,000,000
Exercise 14–30
Requirement 1
June 30, 2018
Interest expense (5% x $184 million) 9,200,000
Requirement 2
December 31, 2018
Interest expense (5% x [$184 million + 1.2 million]) 9,260,000
Requirement 3
Face amount
Less: Discount
Book value at January 1
Face amount
Book value at December 31