Intermediate Accounting Volume 2 Canadian 7th Edition By Beechy – Test Bank

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MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) The accounting classification of a financial instrument is determined by its tax status.
A) True
B) False
Answer: B
2) Induced conversions of convertible debt arise when the debtor offers a “sweetener” to encourage the
creditor to promptly convert the debt.
A) True
B) False
Answer: B
3) When stock rights are issued to current shareholders, it may require more than one such right to later
acquire one additional share of the stock covered by the rights.
A) True
B) False
Answer: B
4) The measurement date of a compensatory stock option must precede the date of grant.
A) True
B) False
Answer: B
5) General debt carries a firm commitment to interest payments and repayment of capital at maturity.
A) True
B) False
Answer: B
6) ASPE records complex financial instruments in keeping with their legal form, while IFRS records
these based on their substance.
A) True
B) False
Answer: B
7) The tax status of a financial instrument is determined by its legal form and not its substance.
A) True
B) False
Answer: B
8) Retractable preferred shares are always classified as debt.
A) True
B) False
Answer: B
9) Redeemable preferred shares are always classified as debt.
A) True
B) False
Answer: B
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10) Options are ONLY for the purpose of buying or selling financial instruments.
A) True
B) False
Answer: B
11) Convertible bonds with a floating conversion price is treated solely as debt.
A) True
B) False
Answer: B
12) If a financial instrument is an equity instrument in substance, but its legal form is debt, any periodic
payments made to investors will be accrued on the company’s financial statements as interest
expense.
A) True
B) False
Answer: B
13) The issuance of stock options will have a positive effect on a company’s debt-to-equity ratio over
time.
A) True
B) False
Answer: B
14) When a bond has interest which may be paid in a fixed number of shares, these bonds would be
classified as equity,
A) True
B) False
Answer: B
15) The bifurcation of the proceeds from the issue of a complex financial instrument between debt and
equity components will be the same, regardless of whether or not the conversion is mandatory.
A) True
B) False
Answer: B
16) The conversion of preferred shares at a premium results in a debit directly to shareholder equity at
the date of conversion.
A) True
B) False
Answer: B
17) Perpetual debt is valued as debt because it has no equity component.
A) True
B) False
Answer: B
2
18) If cash payments to investors are dependent on one or more future events, the instrument in question
would be considered equity.
A) True
B) False
Answer: B
19) Mutual companies will tend to record their instruments as liabilities, since these are redeemable at
any time at the investor’s option.
A) True
B) False
Answer: B
20) Rights granted to existing shareholders entitling them to purchase additional shares result in a credit
to Contributed Surplus.
A) True
B) False
Answer: B
21) Poison pills serve to thwart a takeover bid from an outside (hostile) takeover group.
A) True
B) False
Answer: B
22) Stock appreciation rights (SARS) and share based payments are only payable in common shares or
other equity instruments.
A) True
B) False
Answer: B
23) When interest is repayable to investors at a fixed amount per share, the financial instrument in
question would be considered debt.
A) True
B) False
Answer: B
24) Retractable preferred shares are those which can be redeemed only at the investor’s discretion.
A) True
B) False
Answer: B
25) When preferred shares are classified as debt, their dividends are deducted from Retained Earnings,
thus bypassing earnings.
A) True
B) False
Answer: B
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26) Securities issued as debt, but intended by the issuing corporation to be exchanged for shares by the
investors at some time prior to maturity, are known as “hybrid securities”.
A) True
B) False
Answer: B
27) Perpetual Debt is accounted for as equity.
A) True
B) False
Answer: B
28) Management of a company that has convertible bonds outstanding would likely force conversion of
its bonds of the fair market value of the shares upon conversion exceeds the fair value of the bonds.
A) True
B) False
Answer: B
29) The conversion option attached to convertible bonds, which have a floating conversion price per
share, has an intrinsic value which is based on the fair market value of the shares at the time.
A) True
B) False
Answer: B
30) A financial instrument is any contract that gives rise to a financial asset of one party and a financial
liability or equity instrument of another party.
A) True
B) False
Answer: B
31) Stock options have no intrinsic value when the market price of the share exceeds its conversion
price.
A) True
B) False
Answer: B
32) The proceeds of any bonds sold with detachable stock warrants must be pro-rated between the bonds
and the warrants.
A) True
B) False
Answer: B
33) Share-based payments to suppliers are valued at the value of the goods or services received.
A) True
B) False
Answer: B
4
34) Assume that a company wishes to grant stock options to a supplier in exchange for services
rendered. The company chose to value this exchange at the going market rate charged by the
suppliers’ competitors. This is an example of a Level 2 Fair Value Hierarchy application.
A) True
B) False
Answer: B
35) Under ASPE, preferred shares must be classified as equity while shareholder loans must be
classified as debt.
A) True
B) False
Answer: B
36) Under ASPE, convertible debt must always be treated as debt in its entirety.
A) True
B) False
Answer: B
37) Under ASPE, forfeitures which occur under a stock-based compensation structure are accrued
throughout the vesting period.
A) True
B) False
Answer: B
38) Cash flow hedges do not exist under ASPE.
A) True
B) False
Answer: B
39) Embedded derivatives are those that can be detached and separately sold from their host contracts.
A) True
B) False
Answer: B
40) Under IFRS, forfeitures which occur under a stock-based compensation structure are accrued
throughout the vesting period.
A) True
B) False
Answer: B
41) The crucial aspect of debt is that the creditors can demand payment.
A) True
B) False
Answer: B
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42) An instrument may be classified as equity even though the investor can demand payment.
A) True
B) False
Answer: B
43) One of the most common forms of hybrid security is convertible debt.
A) True
B) False
Answer: B
44) Futures contracts are traded on public exchanges while forward contracts are not.
A) True
B) False
Answer: B
45) Even if the underlying share value of a convertible bond never reaches the conversion price,
management can still force conversion.
A) True
B) False
Answer: B
46) Once the market price of shares rises above the conversion price on convertible bonds, the bond
ceases to trade as debt, and is effectively traded as equity.
A) True
B) False
Answer: B
47) An escalation clause will normally cause preferred shares to trade as debt.
A) True
B) False
Answer: B
48) With respect to convertible bonds, whose conversion is mandatory, only the interest stream is
valued as debt; the bond principal and conversion features are considered equity.
A) True
B) False
Answer: B
49) When bonds are converted, it is first necessary to update any accounts relating to bond premium or
discount, accrued interest, and foreign exchange gains and losses on foreign currency denominated
debt.
A) True
B) False
Answer: B
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50) If it is the company’s option to repay the debentures through the issuance of common shares, the
principal component of the bonds is debt.
A) True
B) False
Answer: B
51) To be classified as retractable preferred shares, the cash repayment must either be contractually
required or at the option of the investor.
A) True
B) False
Answer: B
52) When a bond matures, an investor will convert if the market price of the convertible bond is higher
than the conversion price of the bond.
A) True
B) False
Answer: B
53) When a bond matures, an investor will cash it in if the market price of the convertible bond is higher
than the conversion price of the bond.
A) True
B) False
Answer: B
54) An equity item is classified as debt in the financial statements and dividend payments were shown
on the financial statements. For income tax purposes, the amounts will not be tax deductible.
A) True
B) False
Answer: B
55) Hedge accounting is often performed to minimize any accounting mismatch between the hedged and
hedging items and is strictly voluntary.
A) True
B) False
Answer: B
56) If a company issues debt that is convertible at the corporation’s option, in substance, the debt is
equity.
A) True
B) False
Answer: B
57) Convertible debt that is convertible to a variable number of shares at the investor’s option will
normally be classified as a liability.
A) True
B) False
Answer: B
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58) On January 1st, 2014 ABC Inc. had invoiced a client in New York for $10,000 US for services
rendered that day. ABC did not hedge this receivable. The receivable is due in 60 days. On January
1st, 2014, the spot rate was $1US = $1.02CDN. On January 31st, 2014, the spot rate was $1US =
$1.05CDN. What is the effect of the above information on ABC’s January financial statements?
A) A $300 debit to OCI.
B) A $300 foreign exchange gain.
C) A $300 credit to OCI.
D) A $300 foreign exchange loss.
Answer: B
59) S Corporation created a stock option plan for its two top executives. The plan provided that each
executive would receive 1,000 options, which would enable him or her to purchase 100 shares at 75
percent of the market price on the date the options, became exercisable. The options were
exercisable in two years. At the date of granting the options, the market price of the shares was $12
per share. The date of measurement for the stock option plan was the:
A) date of grant.
B) date the employees’ exercise their options.
C) end of the first year.
D) end of the second year.
Answer: D
60) JKC initiated a stock option plan for its three top executives. The plan provided that each executive
would receive 6,000 options that would enable each one to purchase 600 shares at the option price.
The option price was set at 10 percent below market price at the first exercise date. The options
could be exercised after the executives remained as employees of the company for 3 more years. The
market price of the shares on the date that the options were granted was $10 per share. The amount
of compensation expense the company incurred for the three executives due to the option plan was:
A) $8,100
B) $3,000
C) $0
D) $600
E) Cannot be determined from the information provided.
Answer: E
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61) Compensatory stock options were granted to executives on January 1, 20×3, with a measurement
date of June 30, 20×4, for services to be rendered during 20×3, 20×4, and 20×5. The excess of the
market value of the shares over the option price at the measurement date was reasonably estimable
at the date of grant. The stock option was exercised on October 31, 20×5. Compensation expense
should be recognized in the income statement in which of the following years?
20×3 20×4 20×5
1 No No Yes
2 No Yes Yes
3 Yes No No
4 Yes Yes Yes
A) Choice 1
B) Choice 2
C) Choice 3
D) Choice 4
Answer: D
62) Which of the following are requirements for hedge accounting?
A) Designation and documentation of the hedging relationship.
B) An existing risk management strategy involving hedging.
C) Reasonable expectation of hedge effectiveness.
D) All of these answers are correct.
Answer: D
63) A stock option plan is a compensatory plan if:
A) The employee must work for the company until retirement.
B) It involves a cost to the grantor.
C) The employee must report the option on the employee’s current tax return.
D) The employee must have worked for the company for one year.
Answer: B
64) $10,000 (face value) of bonds was sold with a total of 200 detachable stock warrants attached. Each
warrant conveys the right to purchase one common share at a specified price during a specified time
period. The market immediately valued the warrants at $2 each. The issue sold for 102. The entry to
record the bond issuance would include:
A) cr. bonds payable $10,200
B) dr. owners’ equity account $400
C) dr. bond discount $200
D) dr. bond premium $200
Answer: C
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65) All of the following are examples of derivative instruments except:
A) Foreign exchange forward contracts
B) Currency swaps
C) Retractable preferred shares
D) Interest rate swaps
Answer: C
66) Which of the following is an example of a financial asset?
A) Prepaid expenses
B) Capital assets
C) Inventory
D) accounts receivable
Answer: D
67) In order to determine if, in substance, a complex financial instrument is debt, the answer should be
yes to all of the following except:
A) Is the periodic return on capital obligatory?
B) Is the amount convertible into common shares?
C) Is the debtor legally obligated to repay the principal at a fixed rate?
D) Is the debtor legally obligated to repay the principal at the option of the creditor?
Answer: B
68) In order to determine if, in substance, a complex financial instrument is equity, the answer should be
no to all of the following except:
A) Is the periodic return on capital obligatory?
B) Is the debtor legally obligated to repay the principal at the option of the creditor?
C) Is the debtor legally obligated to repay the principal at a fixed rate?
D) Is the amount convertible into common shares?
Answer: D
69) All of the following are common reasons for a company to issue convertible bonds except:
A) The bonds are issued to controlling shareholders so that they can receive interest payments in
preference to other shareholders.
B) A bond that has a favourable component such as a conversion privilege, can carry a lower
interest rate than a “straight” bond.
C) The company prefers to issue shares, but is unsure of the present stock market and the timing.
D) All of these answers are correct.
Answer: D
10
70) General characteristics of convertible bonds that will be converted include all of the following
except:
A) the company will no longer have to repay the principal amount of the bonds.
B) management fully intends that the conversion privilege will eventually be attractive to the
investors.
C) the market price of the shares will drop below the conversion price.
D) the investors will convert at or before maturity date.
Answer: C
71) Why would a corporation issue retractable preferred share in a private placement rather than a
normal debt arrangement?
A) Income minimization
B) Cash flow
C) The tax treatment of intercorporate dividends
D) None of these answers are correct.
Answer: C
72) Silo Corp. granted to Donna, its superstar accountant, the option to purchase Silo common shares
for $10, on Jan. 1, 20×1. The market price of the shares on that date was $20. The options can be
exercised during the period Jan. 1, 20×4 through Jan. 1, 20×6. The number of shares under option is
determined by a formula based on Silo earnings each year. The number of shares actually under
option will be the formula value on Dec. 31, 20×3. That formula estimated the following number of
shares under option at the end of years: 20×1, 200; 20×2, 300. The formula determined the number
of shares at Dec. 31, 20×3 to be 400. The market prices for Silo shares at the end of years: 20×1,
$25; 20×2, $40, 20×3, $50. What is the recorded compensation expense for 20×2, for Donna?
A) $4,000
B) $4,500
C) $3,000
D) $5,000
E) $7,250
Answer: A
73) A non-compensatory stock option plan means that:
A) No shares are given but shareholders are allowed to be purchased on the open market.
B) Any employee can purchase shares at a discount from the prevailing market price.
C) Top executives are given shares in the company.
D) None of these answers are correct.
Answer: B
74) All of the following are characteristics of stock rights except:
A) Stock warrants never expire
B) Stock warrants can be exercised without having to trade in the bond
C) The warrants are usually detachable
D) Stock warrants can be exercised without having to redeem the bond
Answer: A
11
75) JMR Ltd. issued $300,000 of 7%, 8 year, non-convertible bond with detachable stock purchase
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 20 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive
of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds were quoted
at 103 ex-warrants. The market value of the bonds and warrants using the proportional method was:
A) $350,000
B) $339,000
C) $321,000
D) $605,000
Answer: B
76) JMR Ltd. issued $100,000 of 8%, 8 year, non-convertible bond with detachable stock purchase
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 10 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive
of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds were quoted
at 103 ex-warrants. The market value of the bonds and warrants using the proportional method was:
A) $321,000
B) $108,000
C) $605,000
D) $107,000
Answer: B
77) JMR Ltd. issued $100,000 of 8%, 8 year, non-convertible bond with detachable stock purchase
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 10 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive
of accrued interest. Shortly after issuance, the warrants trade for $5 each and the bonds were quoted
at 103 ex-warrants. The allocation of the proceeds to bonds using the proportional method was:
A) $99,185
B) $108,000
C) $107,000
D) $100,000
Answer: A
78) JMR Ltd. issued $300,000 of 7%, 8 year, non-convertible bond with detachable stock purchase
warrants. KER Corp. purchased the entire issue. Each $1,000 bond carries 20 warrants. Each
warrant entitles KER to purchase one common share for $20. The bond issue sells for 104 exclusive
of accrued interest. Shortly after issuance, the warrants trade for $5 each and there was no market
value for the bond. In the journal entry, the amount of the payable for the bond is:
A) $350,000
B) $339,000
C) $300,000
D) $321,000
Answer: C
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79) On January 1, Year 1, ABC Inc., a publicly traded enterprise, issued $4,000,000 worth of bonds
with detachable stock warrants. The bonds mature on December 31st, Year 4 and pay interest
annually on December 31st at a coupon rate of 6% per annum. The yield to maturity on similar bonds
was 5% at the date of issue. The bonds were issued at 108.
Based on the information provided, which of the following statements is most correct?
A) On the date of issue, the bonds would be valued at $3,821,838 and the warrants would be
valued at $178,162.
B) On the date of issue, the bonds would be valued at $4,000,000 and the warrants would be
valued at $320,000.
C) On the date of issue, the bonds would be valued at $4,000,000 and the warrants would be
valued at $178,162.
D) On the date of issue, the bonds would be valued at $4,141,838 and the warrants would be
valued at $178,162.
Answer: D
80) On January 1, Year 1, ABC Inc., a publicly traded enterprise, issued $4,000,000 worth of bonds
with detachable stock warrants. The bonds mature on December 31st, Year 4 and pay interest
annually on December 31st at a coupon rate of 6% per annum. The yield to maturity on similar bonds
was 5% at the date of issue. The bonds were issued at 108.
Based on the information provided, which of the following statements is most correct?
A) A loss of $39,776.
B) A gain of $51,294.
C) A loss of $51,294.
D) A gain of $39,776.
Answer: C
81) ABC Inc., a publicly traded company, 100,000 granted stock options on January 1, Year 1, with a
total value of $150,000. The option will vest over a three-year period, and employees may exercise
their options as of year 4. On December 31, Year 1, it is estimated that 80% of the options will fully
vest. During Year 2, an executive suddenly quit, forfeiting 20,000 options. On December 31st, Year
2 the estimate of the number of options that will fully vest by the end of Year 3 was revised to
50,000. The December 31st, Year 2 year-end accrual required with respect to these stock options
would include a compensation expense amount of:
A) $25,000.
B) $20,000.
C) $30,000.
D) $10,000.
Answer: B
13
82) An option is:
A) An obligation to sell something in the future.
B) The right to buy or sell something in the future.
C) A debt instrument.
D) An obligation to buy something in the future.
Answer: B
83) A forward contract is:
A) A debt instrument.
B) An obligation to buy or sell something in the future.
C) The right to sell something in the future.
D) The right to buy something in the future.
Answer: B
84) For each type of financial instrument, the reporting enterprise should disclose:
A) The extent and nature of the financial instruments.
B) Significant conditions.
C) Significant terms.
D) All of these answers are correct.
Answer: D
85) Stock Appreciation Rights (SARS) earned by employees may be settled by issuing (choose the best
answer):
A) Promissory notes
B) Shares
C) Cash or Shares
D) Cash
Answer: C
86) Securities issued as debt but intended by the issuing company to be exchanged for shares by the
investor prior to maturity are called:
A) convertible debt
B) discount bonds
C) options
D) hybrid securities
Answer: A
87) Primary securities that have both debt and equity characteristics are called:
A) options
B) convertible debt
C) hybrid securities
D) discount bonds
Answer: C
14
88) VB Ltd. raises $150,000 by issuing a financial instrument that pays interest at a rate of 8% per year
to the investor. At the end of the fourth year, the financial instrument is retired for $155,000. If the
financial instrument is treated as debt then:
A) The repayment will decrease owners’ equity
B) The interest payment decreases retained earnings
C) Shareholders’ equity is increased at issuance
D) Retained Earnings is reduced as the interest payment is treated as a dividend distribution
Answer: B
89) VB Ltd. raises $150,000 by issuing a financial instrument that pays interest at a rate of 8% per year
to the investor. At the end of the fourth year, the financial instrument is retired for $155,000. If the
financial instrument is treated as equity then:
A) The repayment will decrease owners’ equity
B) The interest payment decreases retained earnings
C) Long-term liabilities is increased at issuance
D) If premium on repayment was not known, it is recorded as a loss on the income statement
Answer: A
90) On the statement of cash flows, a hybrid financial instrument should be:
A) Reported as an operating activity
B) Reported as an investing activity
C) Reported according to its individual components
D) Reported as a financial activity
Answer: C
91) The crucial aspect of debt on the financial statements is:
A) the interest payments.
B) the legal agreement.
C) the maturity date.
D) that the creditors can demand payment.
Answer: C
92) A company issues a convertible bond. Management can essentially force conversion as long as:
A) The share price is equal to the conversion price
B) The share price is lower than the conversion price
C) The share price is higher than the conversion price
D) None of these answers are correct
Answer: C
15
93) The incremental method to accounting for convertible bonds means that:
A) The proceeds of the bond are allocated on the basis of the book values of the straight bond and
imbedded stock option
B) The proceeds of the bond are allocated on the basis of the relative market values of the straight
bond and imbedded stock option
C) The stock option is valued at the difference between the total proceeds of the bond issue and
the market value of an equivalent straight bond issue
D) None of these answers are correct
Answer: C
94) If a company issues debt that is convertible at the shareholder’s option, in substance, the debt is:
A) Debt or Equity
B) Debt
C) Equity
D) Subordinated
Answer: B
95) When convertible bonds are submitted for conversion, all of the following must be updated except:
A) Foreign exchange gains and losses on foreign currency denominated debt
B) Accrued interest
C) Bond premium or discount
D) Cash
Answer: D
96) If a company issues debt that is convertible at the corporation’s option, in substance, the debt is:
A) Subordinated
B) Equity
C) An Asset
D) Debt
Answer: B
97) Credit risk is an issue for financial instruments and must be disclosed because:
A) the company may default on its loan
B) the company may not perform their obligations
C) the other parties to financial instruments may not perform their obligations
D) the company may not have enough cash flow to pay suppliers
Answer: C
98) Derivatives may be described as:
A) Common shares
B) Promissory notes
C) Executed contracts
D) Executory contracts
Answer: D
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99) At the end of 2014, interest on a perpetual loan is paid to the holder. The perpetual debt is shown as
an equity instrument. Based on the above the interest is:
A) Deducted on the statement of retained earnings
B) Deducted on the income statement
C) Added to the statement of retained earnings
D) Added for income tax purposes
Answer: A
100) At the end of 2014, interest on a perpetual loan is paid to the holder. The perpetual debt is shown as
an equity instrument. Based on the above the interest is:
A) Added to the income statement
B) Deducted for income tax purposes
C) Deducted on the income statement
D) Added for income tax purposes
Answer: B
101) Which of the following forms part of the definition of a financial liability?
A) A contractual right to receive cash or another financial asset from another party
B) An equity instrument of another entity
C) Cash
D) To deliver cash or another financial asset to another party
Answer: D
102) A financial asset has any of the following characteristics except:
A) A debt instrument of another entity
B) An equity instrument of another entity
C) Cash
D) A contractual right to exchange financial instruments with another party under conditions that
are potentially favourable
Answer: A
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
103) The president of XBC was granted a stock option for 1,000 common shares. On the grant date, the
option price was $40 and the market value was $38 per share. Give the entry to record the option at
the date of the grant.
Answer: No entry is required because the option price exceeds the market price.
104) A company issues a financial instrument for $40,000 paying interest of $4,000 per year. How would
the interest be treated if the instrument was determined to be equity?
Answer: If the financial instrument was classified as equity, the interest payment would be treated as a
dividend distribution and retained earnings would be reduced. There is no impact on the
income statement.
17
105) A company issues a financial instrument for $40,000 paying interest of $4,000 per year. How would
the repayment of the financial instrument be treated if it was determined to be debt?
Answer: If the financial instrument was classified as debt, the repayment of the instrument would
decrease liabilities.
106) What are hybrid securities?
Answer: Hybrid securities have the characteristics of both debt and equity. Their use is gaining
popularity as companies look for more innovative ways to raise funds/minimize their cost of
capital.
107) An investor purchases a $10,000 bond convertible into common shares at a price of $50. How many
shares are available for conversion?
Answer: 10,000/50 = 200 shares
108) In substance, a complex financial instrument will be treated as debt if the answer is yes to two basic
criteria. What are they?
Answer: 1. Are there periodic returns on capital? (Interest payments) 2. Is the borrower required to
repay the principal?
109) Elizabeth Corp. owned a major business building in a small Canadian city. The building has a
$1,345,000 mortgage that is held by a Canadian financial institution (FI). Elizabeth Corp. has had
recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest is
15 months in arrears and totals $145,000. After discussions with the FI, they agree to a financial
reorganization in that they accept $50 preferred shares at a value of $1,490,000, retractable in 15
years time at book value. The shares have first claim on the proceeds of the business building,
should it be sold.
Required:
Prepare the journal entry to record the exchange.
Answer: Please see the following table:
Mortgage payable 1,345,000
Interest payable 145,000
Preferred shares, $20 1,490,000
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110) Amanda Corp. owned a major business building in a small Canadian city. The building has a
$1,555,000 mortgage that is held by a Canadian financial institution (FI). Amanda Corp. has had
recent cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest is
15 months in arrears and totals $132,000. After discussions with the FI, they agree to a financial
reorganization in that they accept $50 preferred shares at a value of $1,490,000, retractable in 15 years
time at book value. The shares have first claim on the proceeds of the business building, should it be
sold.
Required:
Prepare the journal entry to record the exchange.
Answer: Please see the following table:
Mortgage payable 1,555,000
Interest payable 132,000
Preferred shares, $20 1,490,000
Gain on financial reorganization 197,000
111) KIM Corp. owned a major business building in a small Canadian city. The building has a
$1,155,000 mortgage that is held by a Canadian financial institution (FI). KIM Corp. has had recent
cash flow problems, in part, due to the low vacancy rates in the business buildings. Interest is 15
months in arrears and totals $132,000. After discussions with the FI, they agree to a financial
reorganization that results in the FI accepting $800,000 from the shareholders who agree to inject
this amount of cash into the business.
Required:
Prepare the journal entry to record the exchange. What is this called?
Answer: Please see the following table:
Cash 800,000
Common shares 800,000
Mortgage payable 1,155,000
Interest payable 132,000
Cash 800,000
Gain on financial reorganization 487,000
This is called settlement of debt, as the loan will no longer exist after the transaction.
19
112) List the criteria determining whether an asset is a financial asset. Give an example of a financial
asset and a non-financial asset.
Answer: 1. cash
2. A contractual right to receive cash or another financial asset from another party
3. A contractual right to exchange financial instruments with another party under conditions that
are potentially favourable
4. An equity instruments of another entity financial asset: accounts receivable non-financial
asset: inventory
113) List the criteria determining whether liability is a financial liability. Give an example of a financial
liability and a non-financial liability.
Answer: A financial liability is any liability that is a contractual obligation:
1) To deliver cash or another financial asset to another party
2) To exchange financial instruments with another party under conditions that are potentially
unfavourable
Financial liability: accounts payable
Non-financial liability: unearned revenue
114) If a financial instrument is determined to be in substance equity, what are the reporting
implications?
Answer: Any interest payments will be treated as dividend payments with retained earnings being
reduced-in other words the interest does not flow through the income statement. The original
proceeds will be recorded as equity.
115) What is convertible debt? Why would a company issue convertible debt?
Answer: Convertible debt can be exchanged for shares, generally at a specified price. The issuing
company is hoping that the debt will be converted before maturity so that they will not have to
repay the loan. In order for conversion to happen, the market price of the shares must be
higher than the conversion price. The company is generally able to issue the debt with a lower
interest rate as there is a conversion feature attached. In some cases, when the company is
risky, the conversion feature is needed to entice investors. The stock market may be slow and
the company does not want to issue shares.
116) JMR Ltd. purchased $100,000 of bonds convertible into common shares at a price of $50. The
bonds have a maturity date of 20×4. On the maturity date, the market price of the common shares is
$55. Assuming that JMR Ltd. is a knowledgeable investor, what will the company do?
Answer: The company will convert the bonds to common shares as the market price is greater than the
conversion price. JMR Ltd. will get 2,000 shares.
20
117) DWWR Ltd. issues a $150,000, 6%, five-year debenture at par, repayable at maturity in common
shares at DWWR’s option. Interest is repayable annually in cash. Prepare the journal entry at
issuance.
Answer: Please see the following table:
$150,000 (pv,5,6%) = 150,000 x 0.74726 = $112,089
$9,000 (pva,5,6%) = 9,000 x 4.21236 = $37,911
$150,000
Cash 150,000
Interest liability 37,911
Share equity — debenture 112,089
118) WB Ltd. issues a $200,000, 6%, five-year debenture at par, repayable at maturity in common shares
at DWWR’s option. Interest is repayable annually in cash. Prepare the journal entry at issuance.
Answer: Please see the following table:
$200,000 (pv,5,6%) = 200,000 x 0.74726 = $149,452
$12,000 (pva,5,6%) = 12,000 x 4.21236 = $50,548
$200,000
Cash 200,000
Interest liability 50,548
Share equity — debenture 149,452
119) JMR Ltd. issues a $150,000, 7%, five-year debenture at par, repayable at maturity in common shares
at DWWR’s option. Interest is repayable annually in cash. Prepare the journal entry at issuance.
Answer: Please see the following table:
$150,000 (pv,5,7%) = 150,000 x 0.71299 = $106,949
$10,500 (pva,5,7%) = 10,500 x 4.10020 = $43,051
$150,000
Cash 150,000
Interest liability 43,051
Share equity — debenture 106,949
21
120) Why do companies issue retractable preferred shares?
Answer: There are two basic reasons why corporations issue retractable preferred shares. In some
cases, corporations want or need to keep a positive debt-to-equity ratio. In other situations,
corporations are attempting to structure their instruments for tax purposes. Therefore, they
issue retractable preferred shares due to the tax treatment of inter-corporate dividends.
121) KER Corp. issued 150,000 rights allowing the holder to acquire common shares in 3 years’ time at
an acquisition price of $30 per share-the current market price. It takes 5 rights to acquire each share.
The corporation received $40,000 for the rights. Assuming all rights are exercised when the market
price was $35, prepare journal entries at: announcement date, issuance date and exercise date
Answer: No entry on announcement date
Issuance date:
Cash 40,000
Stock rights outstanding 40,000
Exercise date:
Cash 900,000
Stock rights outstanding 40,000
Common shares 940,000
22
122) KER Corp. issued 150,000 rights allowing the holder to acquire common shares in 3 years’ time at
an acquisition price of $25 per share-the current market price. It takes 10 rights to acquire each
share. The corporation received $30,000 for the rights. Assuming that 100,000 rights are exercised
when the market price was $30, and the balance expire, prepare journal entries at: announcement
date, issuance date, exercise date and expiration date.
Answer: 1. Announcement Date: No entry
2. Issuance Date
Cash 30,000
Stock rights outstanding 30,000
3. Exercise date
Cash 250,000
Stock rights outstanding 20,000
Common shares 270,000
4.
Stock rights outstanding 10,000
Contributed capital, lapse of rights 10,000
123) What is a “poison pill”?
Answer: Corporations may try to make it difficult for others to take them over (i.e. takeover bid). At
times they will issue rights that will make it very expensive and very difficult for someone to
obtain control. Generally the rights are issued to existing shareholders for no consideration.
124) JMR Corp. grants their top executive an option for 1,000 shares. The option price is $30 per share.
Prepare the journal entry if the current market price is $40 per share. What would happen if instead
the market price was $25?
Answer: Market price = $40
Compensation expense (40-30)x 1,000 shares 10,000
Common share options outstanding 10,000
Market price = $25
No entry when option granted as the market price is less than the option price
23
125) JMR Ltd. sold $350,000 of 5% (annual interest payments) convertible 5 year bonds at par. The
market interest rate on the sale date was 7%. Each $1,000 bond was convertible into 20 shares of
KER Ltd. no-par value common shares on any interest date after the end of the first year from the
date of issuance. Using IFRS, prepare the journal entry at issuance using the proportional method.
Assume that the option pricing model placed a value of $73,675 for the conversion feature.
Answer: PV of bond:
350,000 x (pv,5,0.07) = 350,000 x 0.71299 = $249,547
(350,000 x 0.05) x (pva,5,0.07) = $17,500 x 4.10020 = $71,754
$321,301
Market Value Proportion Allocation
Liability comp. $321,301 81.3% $284,500
Stock option $73,675 18.7% $65,450
$394,976 100.0% $350,000
Cash (350,000 x 1.01 $353,500
Discount on Bond $65,450
Bonds payable $350,000
Common stock conversion rights $65,450
126) JMR Ltd. sold $350,000 of 5% (annual interest payments) convertible 5 year bonds at 101. The
market interest rate on the sale date was 7%. Each $1,000 bond was convertible into 20 shares of
KER Ltd. no-par value common shares on any interest date after the end of the first year from the
date of issuance. Using IFRS, prepare the journal entry at issuance using the incremental method.
Answer: PV of bond
350,000 x (pv,5,0.07) = 350,000 x 0.71299 = $249,547
(350,000 x 0.05) x (pva,5,0.07) = $17,500 x 4.10020 = $71,754
$321,301
Cash (350,000 x 1.01 $353,500
Discount on Bond $28,699
Bonds payable $350,000
Common stock conversion rights $32,199
127) Explain why a company would want to classify a financial instrument as debt instead of equity?
Answer: Many companies want to classify financial instruments as equity and not debt in order to
improve their debt-to-equity. By recording certain items as equity, they will avoid possible
loan covenant problems. In addition income is affected by the retirement and interest
payments if the item is classified as debt.
24
128) On January 20X2, ABC Corporation issued $1,000,000 face amount of 8%, five year, convertible
debentures. Interest is payable semi-annually on 30 June and 31 December. The debentures are
convertible at the holder’s option at the rate of 20 common shares for each $1,000 bond. The market
rate of interest for non-convertible bonds of similar risk and maturity is 6%. The net proceeds
received by ABC Corporation amounted to $1,250,000.
Prepare a Journal entry to record the issuance of the bonds on 1 January 20X2.
Answer: Please see the following table:
Cash 10,000,000
Interest liability on subordinated debentures
[$800,000(P/A, 8%, .10)]
5,368,064
Share equity — subordinated debentures 4,631,936
129) On January 20X2, ABC Corporation issued $1,000,000 face amount of 8%, five year, convertible
debentures. Interest is payable semi-annually on 30 June and 31 December. The debentures are
convertible at the holder’s option at the rate of 20 common shares for each $1,000 bond. The market
rate of interest for non-convertible bonds of similar risk and maturity is 6%. The net proceeds
received by ABC Corporation amounted to $1,250,000.
Prepare a Journal entry for interest expense on 30 June 20X2 and 31 December 20X2. Assume that
ABC uses straight-line amortization for bond premium and discount.
Answer: Please see the following table:
June 30 20×2
Interest expense 31,470
Premium on Bonds payable ($85,298/10 periods) 8,350
Cash $40,000
Dec. 31 20×2
Interest expense 31,470
Premium on Bonds payable 8,350
Cash $40,000
25
130) On January 20X2, ABC Corporation issued $1,000,000 face amount of 8%, five year, convertible
debentures. Interest is payable semi-annually on 30 June and 31 December. The debentures are
convertible at the holder’s option at the rate of 20 common shares for each $1,000 bond. The market
rate of interest for non-convertible bonds of similar risk and maturity is 6%. The net proceeds
received by ABC Corporation amounted to $1,250,000.
Indicate how all amounts relating to the bonds will be shown on ABC financial statements for the year
ending 31 December 20X2.
Answer: Please see the following table:
Income statement:
Interest expense $62,940
Balance sheet:
Long-term debt
Bonds payable 1,000,000
Premium on bonds payable (85,298 x 4/5) 68,238
Shareholders’ equity
Common share conversion rights 164,702
Cash flow statement:
Financing activities
Proceeds from issuance of convertible bonds 1,250,000
131) On January 20X2, ABC Corporation issued $1,000,000 face amount of 8%, five year, convertible
debentures. Interest is payable semi-annually on 30 June and 31 December. The debentures are
convertible at the holder’s option at the rate of 20 common shares for each $1,000 bond. The market
rate of interest for non-convertible bonds of similar risk and maturity is 6%. The net proceeds
received by ABC Corporation amounted to $1,250,000.
Assume that the holders of $300,000 face value bonds exercise their conversion privilege on 1
January 20X5, when market value of the common shares is $65. Prepare the journal entry to record
the conversion, using the book value method.
Answer: Please see the following table:
Bonds Payable 300,000
Premium on bonds payable 10,236
Common share conversion rights (164,702 x 3/10) 49,411
Common shares 359,647
26
132) On January 1, 2014, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year, subordinated
convertible debentures at face value in a private placement. The debentures pay interest annually, in
cash, on 31 December. The bonds are convertible into 50 common shares for each $1,000 of the
bonds’ face value.
Part A: Prepare Journal entries to record the issuance of the bonds on January 1, 2014. Assume that
the principal will not be repaid. Instead, shares will be issued to the holders of the debentures in
addition to the cash interest paid. In other words, conversion is deemed to be mandatory.
Part B: Prepare Journal entry to record the interest payment on the first interest date of 31 December
2014. Also record the related equity transfer.
Answer: Part A:
Cash 10,000,000
Interest Liability on subordinated debentures (800,000 x
(PA, 8%, 10))
5,368,064
Share equity — subordinated debentures 4,631,936
Part B:
Interest expense (5,368,064 x 8%) 429,445
Interest liability on subordinated debentures 429,445
Interest liability on subordinated debentures 800,000
Cash ($10,000,000 x 8%) 800,000
Retained earnings ($4,631,936 x 8%) 370,555
Share equity — subordinated debentures 370,555
27
133) On January 1, 2014, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year, subordinated
convertible debentures at face value in a private placement. The debentures pay interest annually, in
cash, on 31 December. The bonds were issued for $12 million, and that the market rate was 6%:
Prepare Journal entries to record the issuance of the bonds on January 1, 2014.
Answer: Please see the following table:
Interest Liability on subordinated debentures
(800,000 x (PA, 6%, 10))
5,888,072
Principal on subordinated debentures
(10,000,000 x (PV, 6%, 10))
5,583,950
Present Value of Bonds $11,472,022
Cash 12,000,000
Bonds Payable 10,000,000
Bonds Premium 1,472,022
Share equity — subordinated debentures 527,978
134) On January 1, 2014, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year, subordinated
convertible debentures at face value in a private placement. The debentures pay interest annually, in
cash, on 31 December. The bonds were issued for $12 million, and that the market rate was 6%:
Prepare Journal entry to record the interest payment on the first interest date of 31 December 2014.
Answer: Please see the following table:
Interest expense (11,472,022 x 6%) 688,321
Bond Premium 111,679
Interest liability on subordinated debentures 800,000
Interest liability on subordinated debentures 800,000
Cash ($10,000,000 x 8%) 800,000
28
135) On January 1, 2014, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year, subordinated
convertible debentures at face value in a private placement. The debentures pay interest annually, in
cash, on 31 December. The bonds were issued for $12 million, and that the market rate was 6%:
Assume that on January 1st, 2015, the shares were converted when the market price of the share was
$102. Prepare the required journal entry.
Answer: Please see the following table:
Bonds Payable 10,000,000
Bonds Premium 1,360,343
Share equity — subordinated debentures 527,978
Common shares 11,888,321
Note: The book value method is used for conversion, so the market value of the shares is
irrelevant. The common shares amount is simply a plug.
136) On January 1, 2014, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year, subordinated
convertible debentures at face value in a private placement. The debentures pay interest annually, in
cash, on 31 December. The bonds were issued for $12 million, and that the market rate was 6%:
Assume that the shares were never converted, and the principal was simply repaid at maturity.
Provide the required journal entry.
Answer: Please see the following table:
Bonds Payable 10,000,000
Cash 10,000,000
Share equity — subordinated debentures 527,978
Contributed Capital — Lapsed Conversion rights 527,978
29
137) On January 1, 2014, ABC Incorporated issued $10,000,000 face amount of 8%, 10 year, subordinated
convertible debentures at face value in a private placement. The debentures pay interest annually, in
cash, on 31 December. The bonds were issued for $12 million, and that the market rate was 6%:
Assume that on January 1st, 2015, the bonds were retired for $12.5 million. Valuation models
indicate that $500,000 of the proceeds is attributable to the equity portion, while the balance is
attributable to the bonds. Prepare the required journal entry.
Answer: Please see the following table:
Bonds Payable 10,000,000
Bonds Premium 1,360,343
Share equity — subordinated debentures 527,978
Loss on Bond Retirement 639,657
Contributed Capital — Retirement of share
conversion rights
27,978
Cash 12,500,000
138) On January 1st, 20×9, GHI Inc. granted options to its twenty employees allowing for the purchase of
12,000 shares at $5 per share. The options vest evenly over the 3 years following the date of issue.
The options are only exercisable as of December 31st, 20×11. The fair value of these options (using
an Option Pricing model) is $30,000.
Part A: Assume that all options have vested but that none were exercised on December 31st, 20×11.
Provide the required journal entry.
Part B: Assume that all options have vested and all were exercised on December 31st, 20×11. Provide
the required journal entry.
Part C: Suppose that some of the options were forfeited by the employees. Actual and estimated
forfeiture data are provided in the table below:
Year 1 2 3
Total employees 20 20 20
Employees expected to forfeit 2 (10%) 4 (20%)
Employees expected to remain until vesting 18 (90%) 16 (80%)
Employees actually forfeiting in the year 1 2 0
Employees receiving options 17
Provide the required journal entries to record the accrual of compensation expense and the exercise of
the options as per IFRS.
Part D: Suppose that some of the options were forfeited by the employees. Actual and estimated
forfeiture data are provided in the table below:
Year 1 2 3
Total employees 20 20 20
30
Employees expected to forfeit 2 (10%) 4 (20%)
Employees expected to remain until vesting 18 (90%) 16 (80%)
Employees actually forfeiting in the year 1 2 0
Employees receiving options 17
Provide the journal entries required under ASPE.
Answer: Part A:
Contributed Capital: Common share options
outstanding
$30,000
Contributed Capital: share options expired $30,000
Part B:
Cash $60,000
Contributed Capital: Common share options
outstanding
$30,000
Common shares $90,000
Part C: Although not required, students may find the following table helpful:
Time Period 1 2 3
Fair value 30,000 30,000 30,000
x Cumulative vested fraction = 1/3 = 2/3 = 3/3
x Estimated Retention 90% 80% 85%
Required year-end equity account balance: 9,000 16,000 25,500
Opening balance 0 9,000 16,000
Expense (credit) for the period: 9,000 7,000 9,500
Year 20×9:
Compensation expense $9,000
Contributed Capital Common Share options outstanding $9,000
Year 20×10:
Compensation expense $7,000
Contributed Capital Common Share options outstanding $7,000
Year 20×11:
Compensation expense $9,500
Contributed Capital Common Share options outstanding $9,500
To record the exercise of the options on December 31,
20×11:
Cash $60,000
Contributed Capital Common Share options outstanding $25,500
Common Shares $85,500
31
Part D:
Year 20×9:
Compensation expense $10,000
Contributed Capital: Common share options outstanding $10,000
Year 20×10:
Compensation expense $10,000
Contributed Capital: Common share options outstanding $10,000
Year 20×11:
Compensation expense $5,500
Contributed Capital: Common share options outstanding $5,500*
* = 85%*$30,000 – $10,000 – $10,000
To record the exercise of the options on December 31, 20×11:
Cash $60,000
Contributed Capital: Common share options outstanding $25,500
Common Shares $85,500
Note: Although the accounting for employee stock options is similar under ASPE and IFRS,
under ASPE, no provision is made for forfeitures under ASPE. “Catch-up” is performed
during the year in which the options become exercisable. In this example, both IFRS and
ASPE come to the same Contributed Capital account balance of $51,000 just prior to the
exercise of the options. However, the timing of the related compensation expense differs
under IFRS and ASPE, as shown above. The entry to record the actual exercise of the options
is identical under both IFRS and ASPE.
139) On April 1, Year 1, ABC Inc., a publicly traded company, issued $12,000,000 worth of 5-year,
convertible bonds at 105. The bonds pay interest semi-annually, at a stated annual rate of 6%, each
June 30th and December 31st. The market rate for bonds was 7%. The bonds were dated January 1,
Year 1.
At the date of issue, bond issue costs of $100,000 were incurred. These costs are to be amortized on
straight-line basis at every interest payment date.
Part 1:
Prepare the required journal entries on the following dates:
April 1, Year 1.
June 30th, Year 1.
December 31st, Year 3.
Part 2:
Assume that on March 31st, Year 4, half of the bondholders decided to convert their bonds to
common shares. These bondholders received the interest they were due at that date.
32
Required:
Prepare the required journal entries at that date. Assume that any unamortized bond issue costs
relating to these bonds only were expensed on that date.
Part 3:
Assume that on December 31st, Year 4, ABC Inc. decided to induce (force) conversion of the
remaining bonds, which were trading at 98 on that date, by giving the bondholders an additional
$400,000. Do not record the interest expense accrual or expensing of bond issue costs on this date
for this part (assume that these entries have already been made).
Required:
Prepare the required journal entries at that date.
Part 4:
It is now January 1, Year 1, and Borrower Inc. is in financial distress. It currently holds long-term note
payable due to its bank, the terms of which are as follows:
Principal: $12,000,000 due December 31st, Year 5
Semi-Annual Interest Payments each June 30th and December 31st: $360,000
As a result of the company’s distress, on January 1st, Year 1 Borrower Inc. promptly renegotiated the
terms of its loan as follows:
Principal: $10,000,000 due December 31st, Year 5
Semi-Annual Interest Payments each June 30th and December 31st: $300,000
The market rate of 8% per annum has been unchanged since Borrower took out its initial loan.
Required:
From Borrower Inc.’s perspective, is this a settlement or modification of terms? Explain by showing
calculations and providing the journal entry to adjust the loan if necessary. If no entry is required,
explain why.
Prepare Borrower Inc. June 30th, Year 1 Interest expense entry.
Answer: See separately provided Excel solution.
140) On January 1st, 20×1, 20,000 units of stock appreciation rights were granted to JKL Inc’s 200
employees, each of which received 100 units which accrue evenly over the following three years.
The rights allow the employees to receive cash compensation for any stock price increase on
December 31st, 20×3, if they are still with the company at that time.
The cash to be distributed is the difference between the fair value of the share and the reference price
of $5 per share. Cumulative retention rates are expected to be 80% and 70% for 20×1 and 20×2
respectively. Twenty employees forfeited their rights in 20×1 and thirty forfeited their rights in 20×2.
33
On December 31st, 20×3 there were 150 employees working for JKL Inc.
The following data applies to JKL’s SARS plan:
Year 20×1 20×2 20×3
Market value per share 8 7 10
Reference price per share 5 5 5
Intrinsic value per shares 3 2 5
Estimated fair value per share 4.5 3 n/a
Total fair value (20,000 units) 90,000 60,000
Cash payout value (excluding forfeitures) 100,000
Required:
Prepare the required journal entries for 20×1, 20×2 and 20×3 to record the compensation expense
and ultimate cash payout related to the company’s SARS plan.
Answer: Although not required, students may find the following table helpful:
Time Period 1 2 3
Fair value 90,000 60,000 100,000
x Cumulative vested fraction = 1/3 = 2/3 = 3/3
x Estimated Retention 80% 70% 75%
Required year-end equity account balance: 24,000 28,000 75,000
Opening balance 0 24,000 28,000
Expense (credit) for the period: 24,000 4,000 47,000
Year 20×1:
Compensation expense $24,000
Long-term compensation liability $24,000
Year 20×2:
Compensation expense $4,000
Long-term compensation liability $4,000
Year 20×3:
Compensation expense $4,000
Long-term compensation liability $4,000
To record the cash payout on December 31, 20×3:
Long-term compensation liability $75,000
34
Cash $75,000*
* = 200*75%*100*5
141) Assume that on January 1st, 20×1, Jane Smith is awarded units in an existing Phantom Stock Plan
whereby she can receive either 20,000 common shares or a cash payout equivalent to the value of
15,000 shares at the time.
The shares are worth $5 each upon the inception of the plan. The value of the shares rose to $8 and
$10 each at the end of 20×1 and 20×2 respectively.
Option valuation models valued the company’s stock at $6 per share on January 1st, 20×1.
Jane is her company’s only full-time employee currently eligible under this plan and she has signed a
non-competition agreement which essentially forbids her from seeking employment elsewhere.
Required:
Provide the company’s journal entries to record compensation expense for 20×1 and 20×2 and provide
the necessary journal entries assuming that Jane:
a. Elects to receive shares and
b. Opts for the cash payment, allowing her options to expire.
Answer: Please see the following table:
Equity alternative fair value at plan initiation $100,000
Cash alternative, fair value, at plan initiation $75,000
Equity portion $25,000
20×1:
Compensation Expense (15,000*8+$25,000)/2 $72,500
Contributed Capital — Common Shares
Outstanding
$12,500
Long-Term Compensation Liability $60,000
20×2:
Compensation Expense
((15,000*9+$25,000)-72,500)
$87,500
Contributed Capital — Common Shares
Outstanding
$12,500
Long-Term Compensation Liability $75,000
a. Jane receives shares:
Contributed Capital — Common Shares $25,000
35
Outstanding
Long-Term Compensation Liability $135,000
Common Shares $160,000
b. Jane opts for the cash payout:
Contributed Capital — Common Shares
Outstanding
$25,000
Long-Term Compensation Liability $135,000
Cash $135,000
Contributed Capital — Share options expired $25,000
142) On January 1st, 20×12, ABC Inc. agrees to a futures contract to buy 1,000 shares of DEF Inc. for $20
per share in 60 days. The current value of the shares on January 1, 20×12 is $22 per share.
The broker requires a 20% margin payment. The fair value of the shares is $24 per share on January
31st, 20×12 and $18 per share on February 29th, 20×12.
Required: Prepare all relevant journal entries.
Answer: January 1st, 20×12
Derivative Instrument $2,000
Gain on Derivative Instrument $2,200
Derivative Instrument $4,400
Cash $4,400*
*(20%*($20,000 + $2,000)
January 31st, 20×12
Derivative Instrument $2,000
Gain on Derivative Instrument $2,200
Derivative Instrument $400
Cash $400*
*(20%*$2,000)
February 29th, 20×12
Loss on derivative instrument $6,000
Derivative Instrument $6,000
Investment in DEF Inc. Shares
($18*1,000 shares)
$18,000
Cash $15,200 ($20,000 –
$4,400 – $400)
36
Derivative Instrument $2,800 (balance)
37

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