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ACC 422 > Chapter 16 > Flashcards

Chapter 16 Flashcards

1
Q

Why do companies want to issue convertible bonds?

A

To raise capital and have lower interest payments (lower interest rates), more attractive to investors

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2
Q

What is the accounting entry for the issuance of convertible bonds?

A

Debit cash, credit bonds payable, parallels accounting for straight debt

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3
Q

What is a convertible bond?

A

Hybrid financial instrument composed of debt and equity

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4
Q

What does it mean to bifurcate a bond?

A

cut the instrument into two portions (debt and equity)

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5
Q

How are convertible bonds treated in international standards?

A

Always bifurcated

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6
Q

What happens at conversion of convertible bonds?

A

Book value of bonds is removed and replaced with common stock, discount and premiums also removed

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7
Q

Who initiates the conversion of convertible bonds?

A

the security holder

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8
Q

What type of expense are induced conversions?

A

period expenses

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9
Q

What are stock warrants/options?

A

Entitle the holder to acquire additional common stock within a stipulated period at a specified period

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10
Q

What effect do stock warrants have on EPS?

A

a dilutive effect

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11
Q

What happens upon exercise of a stock warrant?

A

cash is received by the issuer

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12
Q

In what ways can stock warrants be issued?

A

independently or with another security

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13
Q

What are the types of stock warrants issued with other securities?

A

detachable and non-detachable

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14
Q

How are detachable warrants treated?

A

bifurcated because they exist separately

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15
Q

How are nondetachable warrants treated?

A

treated like convertible bonds, cannot be bifurcated because they cannot exist seperately

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16
Q

What methods are used to determine the value of a detachable warrant?

A

proportional method and incremental method

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17
Q

What method is used if the warrant is nondetachable?

A

no allocation to warrants is made

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18
Q

When is the proportional method used?

A

When both the FMV of the bonds and warrants are known

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19
Q

When is the incremental method used?

A

When only one of the FMV of the bonds or warrants are known

20
Q

Proportional Method of Allocation

A

(FMV of bonds or warrants/Total FMV of bonds and warrants) x par value/issuance price

21
Q

Incremental Method of Allocation

A

total receipt (par value) - known FMV of bonds or warrants = FMV of unknown

22
Q

What is the purpose of stock compensation plans?

A

to provide employees incentives that align with shareholders, provide motivation

23
Q

What are types of stock compensation plans?

A

stock option plans, stock appreciation plans, and performance plans

24
Q

How is the value of compensation determined?

A

The Black Scholes Model

25
Q

What is the result of the intrinsic method of measuring compensation (old)?

A

results in overstating of earnings, no compensation expense recognized because few companies used fair value method, and options granted disproportionately to top executives

26
Q

How is compensation expense currently accounted for?

A

debit compensation expense, credit paid in capital (stock options)

27
Q

What are stock appreciation rights?

A

not paying anything out of pocket but get stock appreciation when price goes up

28
Q

What is the result of stock appreciation rights?

A

No risk for employees

29
Q

What is the purpose of reporting earnings per share?

A

allows us to compare between companies and it is the driver of a company’s stock price

30
Q

Where are earnings per share reported?

A

Income Statement

31
Q

What is the main focus for investors?

A

Earnings per Share

32
Q

What is dilution?

A

reduction in EPS which results from conversion of other securities into common stock

33
Q

What is purpose of reporting diluted earnings per share?

A

shareholders want to know extent of reduction in EPS if dilution takes place, report worst case scenario

34
Q

What is the relationship between basic and diluted EPS?

A

Basic EPS is always higher than diluted EPS

35
Q

How is basic EPS calculated?

A

(Net Income-Preferred Dividends)/Weighted Average Outstanding Common Shares

36
Q

What is a simple capital structure?

A

common stock only with no potentially dilutive securities

37
Q

When are preferred dividends subtracted?

A

when cumulative or declared

38
Q

What is complex capital structure?

A

Have potentially dilutive securities such as convertible bonds or preferred stock, options or warrants or other rights that could reduce EPS

39
Q

What are dilutive securities?

A

securities that could reduce EPS

40
Q

What are anti-dilutive securities?

A

securities that could increase EPS

41
Q

How is diluted EPS calculated?

A

((Net Income - Preferred Dividends)/Weighted Average Outstanding Common Shares) - Impact of Convertibles - Impact of warrants, options, and other dilutive securities

42
Q

How is the dilutive effect of convertible securities measured?

A

if-converted method

43
Q

How is the dilutive effect of options and warrants measured?

A

treasury stock method

44
Q

What are the 3 differences between SARS and Stock Options?

A

1) No cash payout by employee, 2) Incorporate market price, 3) Record Liability

45
Q

Process of Computing Diluted EPS

A

1) If-Converted Method for convertible bonds - Interest Savings/New Shares, 2) Treasury Stock Method for stock options - Cash Proceeds, buy back treasury stock, and calculate change in shares

46
Q

What is restricted stock?

A

Gives employees a certain number of stocks in a certain day and can never go underwater

ACC 422 (7 decks)

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