Lesson 28 Flashcards
Why do companies classify nonredeemable common shares as equity and not liability?
Because the issuer has no obligation to pay dividends or repurchase the stock.
Why are convertible securities as well as options, warrants, and other securities often called dilutive securities?
because upon exercise they may reduce (dilute) earnings per share
What are the two main reasons corporations issue convertible securities?
- to raise equity capital without giving up more ownership control than necessary
- to issue convertibles is to obtain debt financing at cheaper rates
What are the times (3) when companies need to record convertible debt?
at issuance, conversion, and retirement
What is induce conversion?
when an issuer wishes to induce prompt conversion of its convertible debt to equity securities, the issuer might offer some form of additional consideration (such as cash or common stock)
Is induce conversion (sweetener) expensed or capitalized?
it is expensed of the current period at the fair value
When retiring convertible debt what should be recognized and included in the JE?
a gain or loss
What is convertible preferred stock?
includes an option for the holder to convert preferred shares into a fixed number of common shares.
Convertible bonds are consider what on the balance sheet?
a liability
Convertible preferred stock is considered what on the balance sheet?
part of the stockholders’ equity
Why doesn’t companies recognize a gain or loss for a convertible preferred stock?
Because preferred stock is part of stockholders’ equity and owners don’t recognize a gain or loss when it deals with equity as business owners.
During the conversion of preferred stock into common, how should any excess of the par value of the common shares issued over the carrying amount of the preferred being converted be treated?
It should be treated as a direct reduction of retained earnings
Correct. In accounting for the exercise of convertible preferred stock, a company uses the book value method and fair values are ignored. The journal entry for the conversion includes: Debit Convertible Preferred Stock (at par), Debit Paid-in Capital in Excess of Par - Preferred Stock, Debit Common Stock (at par). Additionally, if the Preferred Stock entries exceed the Common Stock, an additional credit is made to the Paid-in Capital in Excess of Par - Common Stock account. On the other hand, if the Common Stock credits exceeds the Preferred Stock entries, an additional debit is recorded in the Retained Earnings account to balance the entry.
In 2016, Newton Inc. issued for $105 per share, 100,000 shares of $100 par value convertible preferred stock. One share of preferred stock can be converted into three shares of Newton’s $30 par value common stock at the option of the preferred stockholder. In August 2017, all of the preferred stock was converted into common stock. The market value of the common stock at the date of the conversion was $42 per share.
What total amount should be credited to additional paid-in capital, common stock as a result of the conversion of the preferred stock into common stock?
$1,500,000
Correct. In accounting for the exercise of convertible preferred stock, a company uses the book value method and fair values are ignored. The journal entry for the conversion includes: Debit Convertible Preferred Stock (at par), Debit Paid-in Capital in Excess of Par - Preferred Stock, Debit Common Stock (at par). Additionally, if the Preferred Stock entries exceed the Common Stock, an additional credit is made to the Paid-in Capital in Excess of Par - Common Stock account. On the other hand, if the Common Stock credits exceeds the Preferred Stock entries, an additional debit is recorded in the Retained Earnings account to balance the entry. In this case, the journal entry includes the following: Debit Convertible Preferred Stock: $10,000,000 (100,000 shares x $100/share par value) Debit Paid-in Capital in Excess of Par - Preferred Stock: $500,000 [100,000 x (105/share - 100/share)] Credit Common Stock: $9,000,000 (100,000 preferred shares converted to 3 shares of common stock = $300,000 common shares x $30/share par value) Credit Paid-in Capital in Excess of Par - Common Stock: $1,500,000 [($10,000,000 + $500,000) - $9,000,000]
