On August 31, 2010 Chickasaw Industries issued $25million of its 30-year, 6% convertible bonds dated Auguest 31, priced to yield 5%. The bonds are convertible at the option of the investors into 1,500,000 shares of chickasaw's common stock. Chickasaw records interest expense at the effective rate. On August 31, 2010 investors in Chickasaw's convertible bonds tendered 20% of the bonds for conversation into common stock that had a market value of $20 per share on the date of the conversion. On January 1, 2012 Chickasaw Industries issued $40 million of its 20-year, 7% bonds dated January 1 at a price to yeild 8. On december 31, 2013, the bonds were extinguished early through acquisition in the open market by Chickasaw for 40.5 million.
Required:
1.Using the book value method, would recording the conversation of the 6% convertible bonds into common stock affect earnings? If so, by how much? Would earnings be affected if the market value method is used? If so, by how much?
2.Were the 7% bonds issued at face value, at a discount, or at a premium? Explain.
3.Would the amount of interest expense for the 7% bonds be higher in the first year or second year of the term to maturity? Explain.
4.How should gain or loss on early extinguishment of debt be determined? Does the early extinguishment of the 7% bonds result in a gain or loss? Explain.