Compound Financial Instruments and Note Payable

Problem 1

On January 1, 2013, Monic Company decided to issue 5,000 10-year bonds of 8% P1,000 face value each
with warrants to acquire share capital at P30 per share. The interest on the bonds is payable annually
every December 31. Each bond contains one warrant which can be used to acquire 4 shares of P25 par
value share capital. It is reliably determined that without warrants, the bonds would sell at 114.7 with a
6% effective yield. The bond price with warrants is 120. All warrants are exercised on December 31,
2013.

Required:

Prepare journal entries for 2013 in connection with the bond issuance and the exercise of the warrants.
Use effective interest method of amortization.

Problem 2

On January 1, 2013, Kat Company has decided to raise additional capital by issuing P5,000,000 face value
5-year bonds with interest rate of 12% payable annually on December 31. To help the sale of the bonds,
share warrants are issued – one warrant for each P1,000 bond sold. The warrant entitles the holder to
purchase five shares at P100 per share. The par value of the share is P50.

It is reliably determined that the value of the warrants is P30 each at the time of the issuance of the
bonds. The bonds are sold for P5,100,000 with warrants but would have sold only at P4,657,000 without
the warrants with 14% effective yield.

Required:

Prepare journal entries for 2013 in connection with the bonds including the exercise of the share
warrants. Use effective interest method of amortization.

Problem 3

On January 1, 2013, Zamboanga Company issued P8,000,000 of 12% bonds payable maturing in 5 years.
The bonds pay interest semiannually on June 30 and December 31. The bonds include share warrants
giving the bondholder the right to purchase 16,000 P100 par value shares for P150 per share within the
next three years. The bonds and warrants were issued at 120. The value of the warrants at the time of
issuance was P1,500,000. The market rate of interest for similar bonds without the warrants is 10%. The
PV of 1 at 5% for ten periods is 0.61, and the PV of an ordinary annuity of 1 at 5% for ten periods is 7.72.
All share warrants were exercised on December 31, 2013.

Required:
Prepare journal entries for 2013 in connection with the bonds. Use the effective interest method of
amortization.

Problem 4

Sunshine Company issued 4 -year P5,000,000 face value of 12% convertible bonds at 105 on January 1,
2013, maturing on January 1, 2018 and paying interest annually on December 31.

It is reliably ascertained that the bonds would sell at P4,700,000 without the conversion feature with an
effective yield at 14%.

Each P1,000 bond is convertible into 8 shares of P100 par value share capital. On December 31, 2013, all
of the bonds are converted into share capital.

At this time, the share has a market value of P150 and the bonds are quoted at 101.

Required:

1. Prepare journal entry to record the issuance of the bonds on January 1, 2013.
2. Prepare journal entry to record the interest payment and amortization for 2013. The effective
interest method is used.
3. Prepare journal entry to record the conversion of bonds on December 31, 2013.

Problem 5

On January 1, 2013, Andrea Company issued 4,000 bonds with the P1,000 face value per bond. The
bonds have a three-year life and are issued at 105 or total proceeds of P4,200,000. Interest is payable
annually at 6% every December 31. Each bond is convertible into 20 ordinary shares with P50 par value.

When the bonds are issued, the market rate of interest for similar bonds without the conversion option
is 8%. The PV of 1 at 8% for three periods is 0.79 and the PV of an ordinary annuity of 1 at 8% for three
periods is 2.58.

Required:

1. Prepare journal entry to record the original issuance of the convertible bonds.
2. Prepare journal entry to record full payment of the convertible bonds at maturity on January 1,
2020.

Problem 6

On January 1, 2017, Arlene Company issued convertible bonds with face amount of P5,000,000 for
P6,000,000. The bonds are convertible into 50,000 shares with 100 par value.

The bonds have a 5-year life with 10% stated interest rate payable annually every December 31. The fair
value of the convertible bonds without conversion option is computed at P5,399,300 on January 1, 2017.
On December 31, 2019, the convertible bonds were not converted but fully paid for P5,550,000. On such
date, the fair value of the bonds without conversion privilege is P5,400,000 and the carrying amount is
P5,178,000.

Required:

1. Prepare journal entry to record the original issuance of the convertible bonds on January 1,
2017.
2. Prepare journal entries on December 31, 2019.

Problem 7

On January 1, 2017, West Company acquired a tract of land for P1,000,000. The entity paid P100,000
down, and signed a two-year promissory note for the balance plus 10% interest compounded annually.
The note matures on January 1, 2019.

Required:

Prepare the journal entries to record:

1. Purchase of land on January 1, 2017.

2. Accrued Interest on December 31, 2017.
3. Accrued Interest on December 31, 2018.
4. Full payment of the note on January 1, 2019.

Problem 8

On January 1, 2017, South Company acquired a building for P5,000,000. The entity paid P500,000 down
and signed a noninterest bearing note for the balance which is payable in 3 equal annual installments
every December 31 of each year.

The prevailing interest rate for a note of this type is 12%. The present value of an ordinary annuity of 1
for three periods is 2.4018.

Required: Prepare journal entries to record purchase of building on January 1, 2017, first installment
payment on December 31, 2017 and interest expense for 2017.

Problem 9

On January 1, 2017, Manila Company acquired a tract of land for P5,250,000. The entity paid P1,250,000
down and signed a noninterest bearing note for the balance which is due on January 1, 2020.

There was no established exchange price for the land and the note has no ready market. The prevailing
interest rate for this type of note was 12%. The present value of 1 at 12% for 3 periods is 0.7118.

Required:
Prepare journal entries to record purchase of land on January 1, 2017, interest expense for 2017 and full
payment of the note on January 1, 2020.

Problem 10

On January 1, 2017, Heritage Company has a note payable to bank in the amount of P2,800,000.

Transactions during 2017 and other information relating to liabilities are:

a. Principal amount of the note payable to bank is P2,800,000 and bears a 12% interest. The note is
dated April 1, 2016 and is payable in four equal annual installments beginning April 1, 2017. The
first principal and interest payment was made on April 1, 2017.
b. On July 1, 2017, the entity issued for P1,774,000 a P2,000,000 face amount note to a wealthy
shareholder. The note was date July 1, 2017 and matures on July 1, 2018. No explicit interest
rate is stated in the note and the entire face amount of the note is payable at maturity date.

Required:

a. Prepare journal entries for 2017.

b. Compute the total current liabilities on December 31, 2017.
c. Determine the interest expense to be reported in 2017.

Problem 11

On July 1, 2017, Justine Company borrowed P1,000,000 on a 10% 5-year interest-bearing note. On
December 31, 2017, the fair value of the note is determined to be P975,000.

The entity irrevocably elected the fair value option in measuring the note payable.

Required:

1. What is the interest expense for 2017?

2. What is the carrying amount of the note payable on December 31, 2017?
3. What amount should be reported as gain from change is fair value of the note payable for 2017?