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Four years after issue, debentures with a face value of \(1,000,000 and book value of \)960,000 are tendered for conversion into 80,000 ordinary shares immediately after an interest payment date. At that time, the market price of the debentures is 104, and the ordinary shares are selling at \(14 per share (par value \)10). At date of issue, the company recorded Share Premium— Conversion Equity of $50,000. The company records the conversion as follows.

Bonds Payable 960,000

Share Premium—Conversion Equity 50,000

Share Capital—Ordinary 800,000

Share Premium—Ordinary 210,000

Discuss the propriety of this accounting treatment.

Short Answer

Expert verified

The method utilized by the organization in recording the trading of the convertible debentures for common stocks can be upheld when the organization gives the convertible debentures, and the proceeds can address consideration receivable for the stock. Thus, when a conversion happens, the book value of an obligation is moved to a stock exchange.

Step by step solution

01

Explanation on conversion

An organization's methodology of recording a trading of shares and debentures for common shareholders can be supported on the premise that in any event, when the convertible debentures are given, the returns could reflect though the receivables for a stock.

Therefore, when an obligation is converted, a book value is essentially moved to a stock that was traded for it. Another contention is that a change is an exchange influencing stockholders that truly shouldn't bring about an increase or a misfortune.

02

The propriety of this accounting treatment is as follows

It is easily proven whether the giving of a common stock ought to be recorded in a book worth of the debentures. It very well may be contended that the trading a stock for something like the debentures finishes the payment cycle for the debentures, while beginning another cycle for the stocks.

The pay or worth displayed in this new exchange cycle should be in accordance to the sum received, assuming the debentures were sold instead of traded, or the sums got on the off chance that the related stock were sold, whichever is clearer at the hour of a trade. This approach recognizes changes in values that subordinate a thought laid out at the time a debenture was given.

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Most popular questions from this chapter

Archer Inc. issued $4,000,000 par value, 7% convertible bonds at 99 for cash. If the bonds had not included the conversion feature, they would have sold for 95. Prepare the journal entry to record the issuance of the bonds.

CA16-4 WRITING (Stock Compensation Plans) The following two items appeared on the Internet concerning the GAAP requirement to expense stock options.

WASHINGTON, D.C.—February 17, 2005 Congressman David Dreier (R–CA), Chairman of the House Rules Committee, and Congresswoman Anna Eshoo (D–CA) reintroduced legislation today that will preserve broad-based employee stock option plans and give investors critical information they need to understand how employee stock options impact the value of their shares.

“Last year, the U.S. House of Representatives overwhelmingly voted for legislation that would have ensured the continued ability of innovative companies to offer stock options to rank-and-file employees,” Dreier stated. “Both the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) continue to ignore our calls to address legitimate concerns about the impact of FASB’s new standard on workers’ ability to have an ownership stake in the New Economy, and its failure to address the real need of shareholders: accurate and meaningful information about a company’s use of stock options.”

In December 2004, FASB issued a stock option expensing standard that will render a huge blow to the 21st century economy,” Dreier said. “Their action and the SEC’s apparent lack of concern for protecting shareholders, requires us to once again take a firm stand on the side of investors and economic growth. Giving investors the ability to understand how stock options impact the value of their shares is critical. And equally important is preserving the ability of companies to use this innovative tool to attract talented employees.”

“Here We Go Again!” by Jack Ciesielski (2/21/2005, http://www.accountingobserver.com/blog/2005/02/here-we-go-again) On February 17, Congressman David Dreier (R–CA), and Congresswoman Anna Eshoo (D–CA), officially entered Silicon Valley’s bid to gum up the launch of honest reporting of stock option compensation: They co-sponsored a bill to “preserve broad-based employee stock option plans and give investors critical information they need to understand how employee stock options impact the value of their shares.” You know what “critical information” they mean: stuff like the stock compensation for the top five officers in a company, with a rigged value set as close to zero as possible. Investors crave this kind of information. Other ways the good Congresspersons want to “help” investors: The bill “also requires the SEC to study the effectiveness of those disclosures over three years, during which time, no new accounting standard related to the treatment of stock options could be recognized. Finally, the bill requires the Secretary of Commerce to conduct a study and report to Congress on the impact of broad-based employee stock option plans on expanding employee corporate ownership, skilled worker recruitment and retention, research and innovation, economic growth, and international competitiveness.”

It’s the old “four corners” basketball strategy: stall, stall, stall. In the meantime, hope for regime change at your opponent, the FASB.

Instructions

(a) What are the major recommendations of the stock-based compensation pronouncement?

(b) How do the provisions of GAAP in this area differ from the bill introduced by members of Congress (Dreier and Eshoo), which would require expensing for options issued to only the top five officers in a company? Which approach do you think would result in more useful information? (Focus on comparability.)

(c) The bill in Congress urges the FASB to develop a rule that preserves “the ability of companies to use this innovative tool to attract talented employees.” Write a response to these Congress-people explaining the importance of neutrality in financial accounting and reporting.

What is meant by a dilutive security?

On January 1, 2017 (the date of grant), Lutz Corporation issues 2,000 shares of restricted stock to its executives. The fair value of these shares is \(75,000, and their par value is \)10,000. The stock is forfeited if the executives do not complete 3 years of employment with the company. Prepare the journal entry (if any) on January 1, 2017, and on December 31, 2017, assuming the service period is 3 years.

What are the arguments for giving separate accounting recognition to the conversion feature of debentures?

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