Chapter 14

Solutions

Exercise 14.1

a. PV = (60,000 PMT, 8 I/Y, 4 N, 1,000,000 FV) = $933,757

b. For IFRS, the residual method is used. This allocates the proceeds first to the liability component and the residual to the equity component. The debt component is measured first as the par value compared to the present value of future cash flows without the convertible feature:

Total proceeds at par $1,000,000
PV of the debt component by itself (933,757)
Incremental value of option $66,243

Entry:

General Journal Example

c. Under ASPE, the zero-equity method can be used as a policy choice. The equity component would be measured at $0 and the rest to the debt component.
Entry:
General Journal Example

Also, the residual method can also be used as explained above. Entry is the same as the entry for IFRS:Entry:
General Journal Example


Exercise 14.2

a. Under IFRS, the residual method is applied whereby cash is allocated to the value of the debt instrument first, and the residual is allocated to equity. The debt value is calculated as $576,000 and the warrants are accounted for as equity instruments.
General Journal Example

b. Under ASPE one option is to measure the component that is most easily measurable first (usually the debt component) and apply the residual to the other equity component. This is the option under IFRS, and the journal entry will, therefore, be the same:
General Journal ExampleAnother option is to measure the equity component using the zero-equity method. This means that equity is measured at $0 and the journal entry would be:
General Journal Example

c. Allocating the entire issuance to the debt component, and therefore zero to equity, results in a higher debt to total assets ratio as compared with the residual method. A lower debt to total assets ratio indicates better debt paying ability and long-run solvency.


Exercise 14.3

General Journal Example


Exercise 14.4

a.

General Journal Example
* (\$1,000,000\;per\;value\;+\;\$80,000\;unamortized\;premium)\;\times\;(\$600,000\;\div\;\$1,000,000)
** \$150,000\;\times\;(\$600,000\;\div\;\$1,000,000)

b.

General Journal ExampleNote: The bonds payable carrying value would no longer include any unamortized premium, so the face value or par value would be the carrying value at maturity.

c. Due to common shares market price volatility, there is a risk in waiting to convert the bonds. If the bondholder does not convert when the common share market value is high, no gain will be realized. Conversely, if the common shares market price declines too far, the bondholder risks not being able to sell the bonds, rendering the conversion rights worthless.


Exercise 14.5

Residual method, using the fair value of the warrants first and the residual to the bonds:
General Journal Example
Zero-equity method, which measures the equity component at $0:
General Journal Example


Exercise 14.6

Residual method:
General Journal Example
Zero-equity method, which measures the equity component at $0:
General Journal Example


Exercise 14.7

Fair value of bonds without warrants is (\$400,000\;\times\;\$0.99) = $396,000

General Journal Example


Exercise 14.8

General Journal Example

* \$5,950,000\;-\;(\$6,000,000\;-\;\$350,000)
** \$350,000\;-\;\$300,000


Exercise 14.9

Residual method:

General Journal Example

Zero-equity method:

General Journal Example


Exercise 14.10

a.

General journal example.
* PV (10%, 5N, 135,000 PMT, 1,500,000 FV)

b. IFRS:
General Journal Example
* 1,443,138 × 10% – 135,000 = 9,314

1,443,138 + 9,314 = 1,452,452 × 10% – 135,000 = 10,245

1,452,452 + 10,245 = 1,462,697

Or: Using present values and changing the number of periods from five years to three years: PV (10%, (5 – 2)N, 135,000 PMT, 1,500,000 FV) = $1,462,697

c. ASPE:
General Journal Example
* Same calculation as in previous part
** 1,462,697 – 1,470,000 = 7,303
*** 10,000 – 7,303 = 2,697


Exercise 14.11

a. General Journal Example

* PV(8%, 3N, 50,000 PMT, 1,000,000 FV)

b. General Journal Example

* 922,687\;\times\;8\%\;=\;73,815\;-\;50,000\;=\;23,815

922,687\;+\;23,815\;=\;946,502\;\times\;8\%\;=\;75,720\;-\;50,000\;=\;25,720

946,502\;\times\;25,720\;=\;972,222

** 972,222\;-\;981,462\;=\;9,240


Exercise 14.12

  1. January 1, 2020: No journal entry necessary since the fair value of the forward contract would be $0.
    General Journal Example
  2. General Journal Example

Exercise 14.13

January 1, 2020: No entry on the grant date.

General Journal Example


Exercise 14.14

  1. January 1, 2021: No entry on the grant date.
    General Journal Example
  2. The market price of the shares of $15 on May 1, 2023, is not used in recording the exercise of the stock options. From an accounting perspective, the market price is not relevant. It is, nonetheless, relevant to the employees in making their decision to exercise their stock options. The market price is mentioned to indicate that the timing of the exercise is justified, or at least makes sense. Employees exercising a stock option would have paid $10 and could resell the shares immediately for $15, for a gain of $5 per share.

Exercise 14.15

September 1, Y3 NO ENTRY
this date just indicates that the company adopted a plan - no financial impact
January 1, Y4 NO ENTRY
this is the grant date. This is the start of the plan but no financial impact has occurred.
December 31, Y4 Compensation Expense 174,050
Contributed Surplus - CSOP 174,050
($348,100 total compensation expense / 2 years - exercise period)
December 31, Y5 Compensation Expense 174,050
Contributed Surplus - CSOP 174,050
($348,100 total compensation expense / 2 years - exercise period)
May 1, Y6 Cash (1) 656,250
Contributed Surplus - CSOP (2) 261,075
Common Shares 917,325
(1) Cash = 26,250 shares × $25.00 agreed upon option price
(2) Contributed Surplus = $348,100 × (26,250 options exercised / 35,000 options available)
December 31, Y9 Contributed Surplus - CSOP (1) 87,025
Contributed Surplus - Expired Stock Options 87,025
(1) $174,050 + $174,050 - 261,075


Exercise 14.16

1. Entry at January 1, Y2

Before the entry is prepared, we must determine the present value of the bonds in order to determine the value of the contributed surplus – convertible bonds.

PV $1,555,756
Rate 3%
Nper 4
Pmt -60,000
FV -1,500,000
Type 0

Amount of cash received $1,700,000 (given)
Present value of bond $1,555,756 (without conversion feature)
Value of option $144,244

Jan 1, Y2 Cash 1,700,000
Bonds Payable 1,555,756
Contributed Surplus - convertible bonds 144,244

2. Amortization Schedule

Date

Cash

Interest Expense

Amortization

Carrying Value

Jan 1, Y2 1,555,756
Dec 31, Y2 60,000 46,673 13,327 1,542,429
Dec 31, Y3 60,000 46,273 13,727 1,528,702
Dec 31, Y4 60,000 45,861 14,139 1,514,563
Dec 31, Y5 60,000 45,437 14,563 1,500,000

3. Entry at December 31, Y2

Interest Expense 46,673
Bonds Payable 13,327
Interest Payable (paid January 1, Y3) 60, 000

4. Entry at December 31, Y3

Interest Expense 46,273
Bonds Payable 13,727
Interest Payable (paid January 1, Y4) 60,000
interest is still owed to the bondholders for Y3 because the bonds were outstanding for the year.
Bonds Payable 1,528,702
Contributed Surplus - convertible bonds 144,244
Common Shares 1,672,946
contributed suplus must be cleared since bonds are converted


Exercise 14.17

1. Purchase of options

May 1, Y4 Derivative - Finanacial Asset 325
Cash 325
to record the purchase of the option (derivative)

2. Change in fair value

July 31, Y4 Derivative - Finanacial Asset 7,475
Gain on value of derivative 7,475
to record the increase in value of derivative ($7,800 - 325)

3. Took delivery of share

July 31, Y4 FV-NI Investments (1) 39,700
Loss 600
Cash (2) 32,500
Derivative - Finanacial Asset 7,800
(1) must record at current fair value = 1,000 shares × $39.70
(2) cash is paid at agreed upon price = 1,000 shares × $32.50

4. Settled the option

July 31, Y4 Cash (1) 7,200
Loss 600
Derivative - Financial Asset 7,800
(1) since settle, only receive the difference in share price = 1,000 shares × ($39.70 - $32.50)
note - the loss is the same under both scenarios


Exercise 14.18

Jan 7, Y3 no entry - the fair value of the forward contract is $0.
Jan 20, Y3 Derivative - Financial Asset 675
Gain 675
to record the increase in fair value ($675 - $0)
Mar 15, Y3 Loss 279
Derivative - Financial Asset 279
to record the decrease in fair value ($675 - $396)
May 4, Y3 Derivative - Financial Asset 342
Gain 342
to record the increase in fair value ($738 - $396)
Aug 31, Y3 Cash (1) 57,000
Gain 56,262
Derivative - Financial Asset 738
(1) cash is the difference between market price and contract price = 1,000 ounces × ($2,007 - $1,950)

If Midland took possession (delivery) of the gold

Gold (1) 2,007,000
Gain 56,262
Derivative - Financial Asset 738
Cash (2) 1,950,000
(1) the gold (an asset) would be worth the market value = 1,000 ounces × $2,007
(2) cash paid is the agreed upon amount per ounce = 1,000 ounces × $1,950
note - the gain is the same whether taking delivery or not.

License

Icon for the Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License

Intermediate Financial Accounting 2 Copyright © 2022 by Michael Van Roestel is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.

Share This Book