FAR 5 Flashcards
On July 28, Vent Corp. sold $500,000 of 4%, eight-year subordinated debentures for $450,000. The purchasers were issued 2,000 detachable warrants, each of which was for one share of $5 par common stock at $12 per share. Shortly after issuance, the warrants sold at a market price of $10 each. What amount of discount on the debentures should Vent record at issuance?
The market value of the detachable warrants at issuance is allocated to owners’ equity, with the remainder of the proceeds being allocated to the bonds. The value of the warrants is 2,000 x $10 = $20,000. This leaves $430,000 ($450,000 - $20,000) to allocate to the bond issue. The total face value of the bonds is $500,000, yielding $70,000 of discount (($500,000 - $430,000).
On March 1, 20x2, Evan Corp. issued $500,000 in 10% nonconvertible bonds at 103, due on February 28, 2009. Each $1,000 bond was issued with 30 detachable stock warrants, each of which entitled the holder to purchase, for $50, one share of Evan’s $25 par common stock. On March 1, 20x2, the market price of each warrant was $4. By what amount should the bond issue proceeds increase stockholders’ equity?
Only the warrants have a known market value. Therefore, that value is allocated to the warrants.
Had both the warrants and bonds (without warrants) been quoted, then the issue proceeds would be allocated based on relative sales value.
The total market value of the warrants is $60,000 = 500 bonds x 30 warrants per bond x $4 market value per warrant.
On December 30, 2004, Fort, Inc. issued 1,000 of its 8%, 10-year, $1,000 face value bonds with detachable stock warrants at par.
Each bond carried a detachable warrant for one share of Fort’s common stock at a specified option price of $25 per share. Immediately after issuance, the market value of the bonds without the warrants was $1,080,000, and the market value of the warrants was $120,000.
In its December 31, 2004, balance sheet, what amount should Fort report as bonds payable?
The proceeds of the issue ($1,000,000 because the bonds were issued at par) is allocated based on the relative fair values of the two securities. The total market value of the two securities after issuance is $1,200,000 ($1,080,000 + $120,000). The allocation to the bonds is then $900,000 [($1,080,000/$1,200,000)$1,000,000].
On June 30, 2000, King Co. had outstanding 9%, $5,000,000 face value bonds maturing on June 30, 2005. Interest was payable semi-annually every June 30 and December 31.
On June 30, 2000, after amortization was recorded for the period, the unamortized bond premium and bond issue costs were $30,000 and $50,000, respectively. On that date, King acquired all its outstanding bonds on the open market at 98 and retired them.
On redemption of the bonds at June 30, 2000, what amount should King recognize as gain before income taxes?
A journal entry illustrates the calculation: Bonds payable 5,000,000 Bond premium 30,000 Bond issue costs 50,000 Cash .98($5,000,000) 4,900,000 Gain 80,000 The unamortized bond issue costs reduce the gain because they are an asset that has no further benefit. The write-off simply reduces the gain. Had there been a net loss, the removal of the bond issue costs would have increased that loss.
On 12/31/x1, DInc. owed CInc. the full face value of a 10%, $350,000 note that requires interest payments annually on Dec. 31. DInc. paid the interest due 12/31/x1, but is experiencing financial problems and requested that the loan agreement be restructured. Three years remain in the note term as of today. The two parties agree to the following restructuring agreement:
DInc. will pay no more interest.
DInc. will pay $196,270 one year from today, and that same amount again two years from today (total of two payments of $196,270).
What amount of interest expense will DInc. recognize on 12/31/x2 when the firm makes the first of two payments of $196,270?
The sum of restructured flows (2 x $196,270) exceeds $350,000, which requires that a new interest rate (m) be computed, as follows: $350,000 = $196,270(pva, m, 2). $350,000/$196,270 = (pva, m, 2) = 1.78326. The new rate (m) corresponds to 8%. Interest expense at the end of 20x2 is computed as .08($350,000) = $28,000.
On October 15, 2004, Kam Corp. informed Finn Co. that Kam would be unable to repay its $100,000 note due on October 31 to Finn. Finn agreed to accept title to Kam’s computer equipment in full settlement of the note.
The equipment’s carrying value was $80,000 and its fair value was $75,000. Kam’s tax rate is 30%.
What amounts should Kam report as disposal gain (loss) and restructuring gain for the year ended September 30, 2005?
Kam recognizes an ordinary loss of $5,000 on disposal of the equipment. This is the difference between the equipment’s $80,000 carrying value, and its $75,000 fair value. If Kam had sold the equipment before using it to settle the debt, this amount of gain would have resulted. Being an ordinary gain, it is reported on a pre-tax basis.
The $25,000 recognized restructuring gain is the difference between the book value of the note ($100,000) and the fair value of the equipment ($75,000). The fair value is used because it represents the current sacrifice to retire the debt.
Again, had the equipment been sold first, Kim would have had $75,000 to pay off the debt. When debt is retired for less than its book value, a gain results.
On December 30, 2004, Hale Corp. paid $400,000 cash and issued 80,000 shares of its $1 par value common stock to its unsecured creditors on a pro rata basis pursuant to a reorganization plan under Chapter 11 of the bankruptcy statutes. Hale owed these unsecured creditors a total of $1,200,000. Hale’s common stock was trading at $1.25 per share on December 30, 2004.
As a result of this transaction, Hale’s total stockholders’ equity had a net increase of
The market value of the stock issued to the creditors is $100,000 (80,000 x $1.25). The fair value of consideration paid to settle the debt therefore is $500,000 ($400,000 cash + $100,000 of stock). The gain on settling the debt therefore is $700,000 ($1,200,000 - $500,000 total consideration).
The gain increases owners’ equity by way of net income. The issuance of stock is recorded at market value, $100,000. Thus, the total owners’ equity increase is $800,000 ($700,000 + $100,000). Note that this amount is also the difference between the amount of debt retired ($1,200,000) and cash paid ($400,000).
In a modification of the terms, troubled debt restructure of type II (sum of new flows > book value of debt), what amount of gain is recognized by the debtor?
Although the debtor has an economic gain (the creditor is making a concession), GAAP requires that the debtor compute the new rate of interest based on the restructured cash flows and recognize interest expense over the note term. No gain is recognized by the debtor.
Which of the following errors could result in an overstatement of both current assets and stockholders’ equity?
This error reduces expenses because part of the holiday pay will be held back in ending inventory, which is a current asset. Thus, net income, and therefore OE are overstated, as well as ending inventory, which is a current asset.
Nest Co. issued 100,000 shares of common stock. Of these, 5,000 were held as treasury stock at December 31, 2004. During 2005, transactions involving Nest’s common stock were as follows:
May 3 - 1,000 shares of treasury stock were sold.
August 6 - 10,000 shares of previously unissued stock were sold.
November 18 - A 2-for-1 stock split took effect.
Laws in Nest’s state of incorporation protect treasury stock from dilution. At December 31, 2005, how many shares of Nest’s common stock were issued and outstanding?
Treasury shares are considered issued, but not outstanding. At December 31, 2005:
Number of shares issued = [100,000 (beginning) + 10,000 (new issuance)]2 = 220,000.
Number of shares outstanding =
[95,000 (beginning) + 1,000 TS reissuance + 10,000 (new issuance)]2 = 212,000.
At December 31, 2005, Salo Corp.’s balance sheet accounts increased by the following amounts compared with those at the end of the prior year:
Assets $178,000 Liabilities 54,000 Capital stock 120,000 Additional paid-in capital 12,000 The only charge to retained earnings during 2005 was for a dividend payment of $26,000. Net income for 2005 amounted to
The change in total owners’ equity for the year is $124,000, which equals the difference between the increase in assets and liabilities for the year ($178,000 - $54,000). Contributed capital increased $132,000 ($120,000 + $12,000). The firm paid dividends of $26,000. Thus:
$132,000 + net income - $26,000 = $124,000
net income = $124,000 - $132,000 + $26,000
= $18,000
Rudd Corp. had 700,000 shares of common stock authorized and 300,000 shares outstanding at December 31, 2004. The following events occurred during 2005:
January 31 Declared 10% stock dividend
June 30 Purchased 100,000 shares
August 1 Reissued 50,000 shares
November 30 Declared 2-for-1 stock split
At December 31, 2005, how many shares of common stock did Rudd have outstanding?
Stock dividends and splits increase the number of shares outstanding on the date of distribution by the percentage effect implied by the dividend (10%) or split (100% or multiply by 2). The number of shares outstanding at 12/31/92 = [300,000(1.10) - 100,000 + 50,000]2 = 560,000.
Treasury shares reduce the number of shares outstanding, and reissuance increases the number of shares outstanding. The total number of shares outstanding just before the split (280,000) is doubled in a 2-for-1 split
On July 1, 2005, Cove Corp., a closely-held corporation, issued 6% bonds with a maturity value of $60,000, together with 1,000 shares of its $5 par value common stock, for a combined cash amount of $110,000.
The market value of Cove’s stock cannot be ascertained. If the bonds were issued separately, they would have sold for $40,000 on an 8% yield to maturity basis.
What amount should Cove report for additional paid-in capital on the issuance of the stock?
The amount of the proceeds allocated to the stock is $70,000 ($110,000 - $40,000). When only one of the two securities has a known market value, that value is allocated to that security and the remaining proceeds are allocated to the security without a known market value.
The total par value of 1,000 shares of $5 par stock is $5,000. Therefore, $65,000 ($70,000 - $5,000) is recorded in additional paid-in capital on common stock.
On March 1, 2005, Rya Corp. issued 1,000 shares of its $20 par value common stock and 2,000 shares of its $20 par value convertible preferred stock for a total of $80,000.
At this date, Rya’s common stock was selling for $36 per share, and the convertible preferred stock was selling for $27 per share.
What amount of the proceeds should be allocated to Rya’s convertible preferred stock?
The total proceeds are allocated to the two securities based on relative market values.
Market value of common: 1,000($36) = $36,000
Market value of preferred: 2,000($27) = 54,000
Total market value $90,000
Allocation of proceeds to preferred = ($54,000/$90,000)$80,000 = $48,000
500 shares of 6%, $100 par callable preferred stock are called at $101. The shares were issued at $103 per share. The journal entry to record the retirement includes which of the following?
The $2 difference multiplied by 500 shares yields $1,000 paid in capital kept by the firm. The journal entry is:
DR: Preferred stock 500($100) 50,000
DR: PIC-preferred 500($103 - $100) 1,500
CR: PIC-retirement of preferred 1,000
CR: Cash 500($101) 50,500
