Chapter 15: Financial Instruments: Complex Debt and Equity
Assignment 15-3
Case 1
Financial Instrument: Liability. The company can avoid a cash payout but the price of shares is not pre-determined. This is a liability, not a residual equity interest.
Case 2
Financial Instrument: Equity. Both principal and interest may be satisfied with common shares and the price is pre-determined, transferring price risk to the investor.
Case 3
Financial Instrument: Liability: Term preferred shares involve a requirement for the company to pay out cash for principal at maturity. The dividend is also a liability (must be paid in cash) and must be accrued over time.
Case 4
Financial Instrument: Liability. The company has a legal obligation to pay annual interest, so it (present value of interest payments) is clearly a liability. The principal portion may be converted to equity if the company wishes, but the price is not set and price risk is not transferred to the investor. This is a liability, not a residual equity interest.
Case 5
Financial Instrument: Equity. The company cannot be forced to pay out cash.
Case 6
Financial Instrument: Liability. The terms of the shares are such that any prudent Board of Directors would arrange to retire the shares prior to the dividend and retirement price escalation. This represents a probable future cash outflow: a liability.
Case 7
Financial Instrument: Compound: Part liability (interest) and part equity (principal). The company has a legal obligation to pay annual interest, so the present value of interest payments is a liability. The principal portion may be converted to equity at a set price if the company wishes, and thus the price risk has passed to the lender. The company cannot be forced to pay out cash: this is a residual equity interest.
Assignment 15-7
Requirement 1
Cash...... 5,325,000
Discount on bonds payable (2)...... 760,000
Bonds payable...... 5,000,000
Contributed capital: common stock
conversion rights (1)...... 1,085,000
(1) $5,325,000 – $4,240,000
(2) $5,000,000 – $4,240,000
The conversion rights are valued at the difference between the actual proceeds and the amount that would have been received had the bond not been convertible.
Requirement 2
Present value:
Principal $5,000(P/F,10%,15 yrs) (.23939) $1,197
Interest 400(P/A,10%,15 yrs) (7.60608) 3,042
Price $4,239 (rounded to $4,240)
Requirement 3
Interest expense ($4,240,000 × .10) $424,000
Requirement 4
Less interest expense would be recorded if the bond were initially valued with a premium. Annual premium amortization would reduce interest expense to an amount lower than the cash paid, versus discount amortization, which increases interest expense over cash paid.
Another way to express this is to point out that issuance at a premium means a yield rate higher than the stated rate, while issuance at a discount means that the yield rate is lower than the stated rate.
Assignment 15-19
Requirement 1
20X3
Compensation expense ($3 x 25,000 x 1/3 x 83%) 20,750
Long-term compensation liability 20,750
20X4
Compensation expense ($12 x 25,000 x 2/3 x 80%) - $20,750 139,250
Long-term compensation liability 139,250
20X5
Compensation expense (($19-$10) x 25,000 x 22/30 ) - $160,000 5,000
Long-term compensation liability 5,000
20X5 - payment
Long-term compensation liability (($19-$10) x 25,000 x 22/30 ) 165,000
Cash 165,000
Requirement 2
The actual turnover in 20X4 was four people, bringing the 20X3 and 20X4 turnover to five people. An estimate of five people leaving, as was used at the end of 20X3, was low and leaves no room for departures in 20X5. The estimate used at the end of 20X4 assumed that one more manager would leave in 20X5 and this, too, was optimistic, since three left.
Requirement 3
If the managers could take cash or shares on settlement, then a compound instrument is reflected in the financial statements. The value of the option is estimated when the plan is initiated, and is accrued over the vesting period, trued up to the retention rate. The liability portion is also recorded over the vesting period, as shown above, with estimates corrected annually for fair value and retention.
Assignment 15-31
Requirement 1
a)Contributed capital: employee share options outstanding.64,000*
Cash [(16,000/2) × $27.50]...... 220,000
Common shares, no-par, 8,000 shares...... 284,000
*160,000 × (16,000 ÷ 40,000) = $64,000
b)Land...... 75,000
Contributed capital: common share rights
outstanding...... 75,000
Note: Transaction valued at the value of land received.
c)Common shares, no-par (1), 40,000 shares...... 1,440,000
Retained earnings...... 440,000
Cash ($47 × 40,000)...... 1,880,000
(1)$32,940,000 + $284 ÷ (915 + 8) = $36 × 40,000
d)Treasury shares (10,000 × $44)...... 440,000
Cash...... 440,000
e)Dividends, common 857,000 (1) × $1...... 857,000
Dividends, preferred 60,000 x $8...... 480,000
Cash...... 1,337,000
(1)915,000 + 8,000 – 40,000 – 26,000 treasury shares
f)Preferred shares, 24,000 shares (1)...... 2,424,000
Common shares, 64,000 shares (24,000 × 8/3).... 2,424,000
(1)$6,060,000/ 60,000 = $101 × 24,000
g)Interest expense ($4,997,000 x 7.8%)...... 389,766
Interest liability- 8% bond...... 389,766
Interest liability – 8% bond ($10,000,000 x 8%)..... 800,000
Cash...... 800,000
h)Contributed capital: common share warrants...... 660,000
Cash (60,000 × $32.50)...... 1,950,000
Common shares, no-par, 60,000 shares (1)...... 2,390,000
Contributed capital: lapse of warrants...... 220,000
(1)$1,950,000 + $440,000
i)Employee stock option expense ($720,000 x ¼ x 90%)………….162,000
Contributed capital: employee shareoptions outstanding 162,000
j)Preferred shares (10,000 × $101 (see f))...... 1,010,000
Contributed capital on preferred share retirement (balance) 55,000
Retained earnings...... 5,000
Cash (10,000 × $107)...... 1,070,000
k)Cash (20,000 x $32)...... 640,000
Retained earnings, loss on sale of treasury shares ..... 92,400
Treasury shares (1)...... 732,400
(1)$512,000 + $440,000 ÷ (16,000 + 10,000) = $36.62 × 20,000
l)Stock dividends, common (1)...... 3,003,000
Common shares, no-par, 96,000 shares × $30.... 2,880,000
Contributed capital: common share fractional
share rights (4,100 × $30)...... 123,000
(1)915,000 + 8,000 – 40,000 + 64,000 + 60,000 – 6,000 treasury shares
= 1,001,000 × 10% = 100,100 shares × $30
Requirement 2
Interest liability – 8% bond ($4,997,000 +$389,766 - $800,000)$ 4,586,766
Share equity - 8% bonds 5,102,000
Convertible $8, no-par preferred shares
($6,060,000 – $2,424,000 – $1,010,000) 2,626,000
Class A no-par common shares
($32,940,000 + $284,000 – $1,440,000 + $2,424,000
+ $2,390,000 + $2,880,000) 39,478,000
Employee share options outstanding 258,000
($160,000 – $64,000 + $162,000)
Common share options (non-employee) 75,000
Contributed capital: common share fractional share rights 123,000
Contributed capital: lapse of warrants 220,000
Retained earnings
($116,300,000 + $6,200,000 (includes newly recorded expenses)
– $440,000 – $857,000 – $480,000 - $5,000 – $92,400 – $3,003,000) 117,622,600
Treasury shares ($512,000 + $440,000 – $732,400) (219,600)