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Question: . Mae Jong Corp. issues \(1,000,000 of 10% bonds payable which may be converted into 10,000 shares of \)2 par value ordinary shares. The market rate of interest on similar bonds is 12%. Interest is payable annually on December 31, and the bonds were issued for total proceeds of $1,000,000. In accounting for these bonds, Mae Jong Corp. will:

(a) first assign a value to the equity component, then determine the liability component.

(b) assign no value to the equity component since the conversion privilege is not separable from the bond.

(c) first assign a value to the liability component based on the face amount of the bond.

(d) use the “with-and-without” method to value the compound instrument.

Short Answer

Expert verified

Answer

Correct option: d: use the “with-and-without” method to value the compound instrument.

Step by step solution

01

The explanation for the correct option

A convertible bond alludes to a bond that pays a fixed pay and can be converted into stock offers. This change occurs at a specific time with a specific conversion ratio and price value. Whenever a bond is converted into a ratio and a price value, interestingly, the bond cost is a lot higher than the conversion price. For a given situation, the with-and-without technique can be utilized for a valuation of a compound instrument as this strategy is utilized for non-contend arrangements. Therefore, option d is the correct answer.

02

The explanation for the incorrect options

Option a: A liability component is estimated at a fair worth, and afterwards the rest of the returns are designated to an equity component.

Option b: Allocate no worth to an equity component value part since the transformation honour isn't distinguishable from the bond, and is not a method that will be adopted.

Option c: The Mae Jong Corp will not first assign a value to the liability component based on the face amount of the bond.

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Most popular questions from this chapter

Briefly discuss the convergence efforts that are under way by the IASB and FASB in the area of dilutive securities and earnings per share.

CA16-2 ETHICS (Ethical Issues—Compensation Plan) The executive officers of Rouse Corporation have a performance-based compensation plan. The performance criteria of this plan is linked to growth in earnings per share. When annual EPS growth is 12%, the Rouse executives earn 100% of the shares; if growth is 16%, they earn 125%. If EPS growth is lower than 8%, the executives receive no additional compensation.

In 2014, Joan Devers, the controller of Rouse, reviews year-end estimates of bad debt expense and warranty expense. She calculates the EPS growth at 15%. Kurt Adkins, a member of the executive group, remarks over lunch one day that the estimate of bad debt expense might be decreased, increasing EPS growth to 16.1%. Devers is not sure she should do this because she believes that the current estimate of bad debts is sound. On the other hand, she recognizes that a great deal of subjectivity is involved in the computation.

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Answer the following questions.

(a) What, if any, is the ethical dilemma for Devers?

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(c) How should Devers respond to Adkins’s request?

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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

Stockholder’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.

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