Chapter 14

Michael Van Roestel

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:

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:

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

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.

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:
Another 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:

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

Exercise 14.4

a.

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

b.

Note: 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:

Zero-equity method, which measures the equity component at $0:

Exercise 14.6

Residual method:

Zero-equity method, which measures the equity component at $0:

Exercise 14.7

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

Exercise 14.8

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

Exercise 14.9

Residual method:

Zero-equity method:

Exercise 14.10

a.

* PV (10%, 5N, 135,000 PMT, 1,500,000 FV)

b. IFRS:

* 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:

* Same calculation as in previous part
** 1,462,697 – 1,470,000 = 7,303
*** 10,000 – 7,303 = 2,697

Exercise 14.11

a.

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

b.

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

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

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

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

Exercise 14.12

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

Exercise 14.13

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

Exercise 14.14

January 1, 2021: No entry on the grant date.
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.

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