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Which of the following statements is correct?

a) IFRS separates the proceeds of a convertible bond between debt and equity by determining the fair value of the debt component before the equity component.

b) Both IFRS and GAAP assume that when there is a choice of settlement of an option for cash or shares, share settlement is assumed.

c) IFRS separates the proceeds of a convertible bond between debt and equity, based on relative fair values.

d) Both GAAP and IFRS separate the proceeds of convertible bonds between debt and equity.

Short Answer

Expert verified

Correct option: a. IFRS separates the proceeds of a convertible bond between debt and equity by determining the fair value of the debt component before the equity component.

Step by step solution

01

The explanation for the correct option

In the IFRS, all the convertible bonds are separated, which implies a partition into the value part of a bond issue and a debt component. The IFRS additionally states that there should be a different distinguishing liability and equity, and treat them in accordance with the financial statements. Because of the accessibility of a conversion option, convertible bonds carry lower interest rates than an ordinary debt.

02

The explanation for the incorrect options    

Option b: Both the IFRS and the GAAP accept that when there is a decision of repayment of an option for cash or shares, the expectations of a share repayment is an incorrect statement.

Option c: The IFRS does not separate the proceeds of a convertible bond between a debt and an equity based on relative fair values.

Option d: Both the GAAP and the IFRS do not separate the proceeds of convertible bonds between a debt and an equity.

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Most popular questions from this chapter

Pechstein Corporation issued 2,000 shares of \(10 par value common stock upon conversion of 1,000 shares of \)50 par value preferred stock. The preferred stock was originally issued at \(60 per share. The common stock is trading at \)26 per share at the time of conversion. Record the conversion of the preferred stock

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Financial Statement Analysis Case

Ragatz, Inc.

Ragatz, Inc., a drug company, reported the following information. The company prepares its financial statements in accordance with GAAP.

2017 (000)

Current liabilities

\(554,114

Convertible subordinated debts

648,020

Total liabilities

1,228,313

Stockholderโ€™s equity

176,413

Net income

58,333

Analysts attempting to compare Ragatz to drug companies that issue debt with detachable warrants may face a challenge due to differences in accounting for convertible debt.

Instructions

(a) Compute the following ratios for Ragatz, Inc. (Assume that year-end balances approximate annual averages.)

(1) Return on assets.

(2) Return on common stock equity.

(3) Debt to assets ratio.

(b) Briefly discuss the operating performance and financial position of Ragatz. Industry averages for these ratios in 2017 were ROA 3.5%; return on equity 16%; and debt to assets 75%. Based on this analysis, would you make an investment in the companyโ€™s 5% convertible bonds? Explain.

(c) Assume you want to compare Ragatz to an IFRS company like Merck (which issues nonconvertible debt with detachable warrants). Assuming that the fair value of the equity component of Ragatzโ€™s convertible bonds is \)150,000, how would you adjust the analysis above to make valid comparisons between Ragatz and Merck?

On January 1, 2017, Barwood Corporation granted 5,000 options to executives. Each option entitles the holder to purchase one share ofBarwoodโ€™s \(5 par value common stock at \)50 per share at any time during the next 5 years. The market price of the stock is \(65 per share on the date of grant. The fair value of the options at the grant date is \)150,000. The period of benefit is 2 years. Prepare Barwoodโ€™s journal entries for January 1, 2017, and December 31, 2017 and 2018.

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