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Intermediate Accounting > Dilutive Securities > Flashcards

Dilutive Securities Flashcards

1
Q

at Par =

A

face value = PV

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2
Q

PV(bond) =

A

= PV of principal + PV of interest

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3
Q

Bond issued at par (face value): entry for issuance time

A

debit:
- cash (proceeds)
credit:
- Bonds payable (PV of bond)

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4
Q

Bond issued at par (face value): entry for end of the year

A

debit:
- Interest expense
credit:
- cash

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5
Q

Bond issued at par (face value): entry at maturity

A

debit:
- Interest cash
- bond payable (PV of the bond)

credit:
- Cash

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6
Q

When issuing bonds, there are 3 scenarios:

A
  1. At par (or face value) -> market rate = interest rate -> PV=FV
  2. Below (at discount) -> Market rate > interest rate -> PV<FV
  3. Above (at premium) -> Market rate < interest rate -> PV>FV
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7
Q

Bond issued at discount : entry issuance time

A

debit:
- cash (use the PV under market rate of interest)
credit:
- Bond payable (PV of bond under market rate)

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8
Q

Bond issued at discount : entry end of the year

A

-> need to discount for amortization: effective-interest method.

debit:
- Interest expense (based the yield(aka interest)% * pv under intereset raet)
credit:
- cash (amount * %bond, based on principal)
- bonds payable

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9
Q

Bond issued at discount: entry at maturity

A

debit:
- Interest expense
- Bond payable
credit:
- Cash
- bonds payable

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10
Q

General rule for cash in bound issued at discount :

A

The cash you issue is based on the principal under the interest rate.

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11
Q

General rule for interest expense in bond issued at discount:

A

The interest expense is based on the PV of the bond (computed under the market rate of interest) which we take %makret of interest% each year.

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12
Q

General rule for the bonds payable in bond issued at discount:

A

The bond payable is based on the adding the difference between cash paid and interest expense (which is called the discount amortized) and adding it back to the carrying amount.

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13
Q

What is the economic intuition behind Effective-interest method ?

A

Bonholders pay less than Principal value of a bond, but still demand to be paid the Principal value at maturity.

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14
Q

What is a convertible bond?

A

Bonds (debt) that can be changed into other corporate securities (shares/equity).

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15
Q

What are advantages of buying convertible debt for investors?

A

Benefit of bonds (guaranteed interest and principal) and holder has the option to change it for shares.

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16
Q

Benefits of convertible bonds for firms?

A

Raise equity capital without giving up more ownership control than necessary.
Obtain debt financing at cheaper rates.
- Tax advantages (interest expense lowers taxable income).

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17
Q

How to deal with convertible bonds ?

A
  • Use the with-and-without method.
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18
Q

How does the with-and-without method work?

A

This method splits the total FV of convertible bond into liability and equity component with the help of 3 key steps at date of issuance:

FV of convertible bond - FV of liability = FV of equity component.

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19
Q

Issuance of convertible bond: entry issuance date

A

Debit:
- Cash
Credit:
- Bonds Payable
- Share premium - Conversion equity

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20
Q

Important things to know about Share premium - conversion equity:

A
  • Does not represent ownership for bond holders
  • Represents what bondholders are willing to pay for option to convert.
21
Q

Issuance of convertible bond: end of the year entry.

A

Debit:
- Interest expense
Credit:
- Cash (based on FV)
- Bonds payable (based on carrying value)

22
Q

Issuance of convertible bond: end of the year

A

Debit:
- Interest expense
Credit:
- Cash
- Bonds payable

23
Q

What are the 4 scenarios of settlement of convertible bonds?

A
  1. Repurchase at maturity
  2. Conversion at maturity
  3. Conversion before maturity
  4. Repurchase before maturity
24
Q

Journal entry for repurchase at maturity

A

When you repurchase a bond at maturity: bond holders don’t have any intent to convert hence the conversion option has no value to bondholder anymore. You don’t have to pay them for giving up conversion option.

amount originally allocated to equity as Share Premium - Conversion Equity does not disappear! -> goes to share premium-share ordinary

Debit:
- Bonds payable
- Share Premium-Conversion Equity
Credit:
- Cash
- Share premium - ordinary

25
Q

Journal entry of conversions of bonds at maturity

A

Debit:
- Bonds payable
- Share premium-Conversin equity
Credit:
- Share capital-ordinary
- Share premium - ordinary

26
Q

Journal entry for conversion before maturity

A

Debit:
- Bonds payable
- Share premium-conversion equity
- Conversion expense
Credit:
- Share capital - ordinary
- share premium -ordinary
- cash

27
Q

What is a repurchase before maturity?

A

The company repurchase the bonds

28
Q

What needs to be done before repurchase pf the bonds?

A
  1. Determine FV of the entire convertible debt instrument
  2. Determine fair value of the liability component on the repurchase day.
  3. Get book (carrying) value of the liability component
  4. Determine the loss/gain on sale
  5. Determine the FV of the equity component
29
Q

What are convertible preference shares?

A

Include option to convert into ordinary shares

30
Q

Issuance of preference share: entry date of issuance

A

Debit:
- Cash
Credit:
- Share capital - preference
- Share premium - ordinary

31
Q

Entry conversion of preference shares?

A

Debit:
- Share capital - preference
- Share premium - conversion equity
Credit:
- Share capital - ordinary
- Share premium - ordinary

32
Q

Journal entry upon call of preference share

A

Debit:
- Share capital- preference
- Share premium - conversion equity
- retained earnings
Credit:
- Cash

33
Q

What is a warrant?

A

Give the holder right (not obligation) to acquire shares at a certain price within a certain period. They are issued with bonds or are part of compensation plans.

34
Q

What is an ESO?

A

Employee stock option, 1st source of compensation during 1990. They are components of compensation: fixed, bonus, long-term

35
Q

What is expected from IFRS for ESOs? And what are 2 general issues regarding this approach?

A

Firms must recognize the FV of the options granted as a compensation expense in their income statement.

Issues:
1. How to determine compensation expense?
- Intrinsic value method
- Fair value method (ifrs)
2. Over what perios to allocate compensation expense?
- Recognize everything immediatly
- or, match it to service period (ifrs)

36
Q

Accounting for ESO: Entry grant day

A

No entry

37
Q

Accounting for ESO: entry each year of service period

A

Debit:
- Compensation expense (amount/nbr of years)
Credit:
- Share premium-sahre options

38
Q

Accounting for ESO: Entry for exercise

A

Debit:
- Cash
- Share premium - share options
Credit:
- Share capital - ordinary
- Share premium - ordinary

39
Q

Accounting for ESO: violation of service time

A

all compensation foregone must be reversed to share-premium -share option.

40
Q

What are restricted shares?

A

Alternative to ESO for compensation. They cannot be sold or transferred until vesting has occurred.

41
Q

What are the major advantages of restricted shares?

A
  1. Become never completely worthless (ESO is worthless if share price < exercise price after vesting period)
  2. Result in less dilution to existing shareholders if stock price increases in future.
  3. bETTER ALIGN INCENTIVES (more long term)
42
Q

What is EPS?

A

EPS = earnings per share, indicates the net income earned by each ORDINARY share

43
Q

Basic EPS =

A

= [Net income - Preference dividends] / weighted-Average ordinary shares outstanding.

44
Q

Why do we weight the share in EPS?

A

Companies issue/purchase shares during the year, which affect the amount outstanding.

45
Q

Diluted EPS =

A

= [net income-Preference dividends] / weighted-average-shares-outstanding - impact of convertibles - Impact of options, warrants, and other dilutive securities.

46
Q

What are the 2 methods for the diluted EPS?

A
  • If-converted method : for convertible bond and (cumulative) convertible preference shares.
  • Treasury-share method: for options and warrants.
47
Q

How does the if-converted method work?

A

This method assumes conversion at the beginning of period if bonds issues in previous period (affect denominator) and ADD BACK preference dividends (no tax effect here as preference dividends are not tax-deductible) (affect the numerator)

48
Q

How does the treasury share method works?

A

Intermediate Accounting (7 decks)

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