Monday, December 15, 2008

MULTIPLE CHOICE—Conceptual

1. Convertible bonds
d. may be exchanged for equity securities.

2. The conversion of bonds is most commonly recorded by the
d. book value method.

3. Gains or losses on the early extinguishment of convertible debt should be considered an
c. unusual item.

4. The conversion of preferred shares may be recorded by the
b. book value method.

5. When the cash proceeds from a bond issued with detachable shares warrants exceeds the sum of the par value of the bonds and the fair market value of the warrants, the excess should be credited to
d. premium on bonds payable.

6. A convertible debt security is recorded as a debt instrument
c. and an equity component.

7. Shares warrants outstanding should be classified as
d. none of these.

8. The date on which to measure the compensation element in a shares option granted to a corporate employee ordinarily is the date on which the employee
a. is granted the option.

9. Compensation expense resulting from a compensatory shares option plan is generally
c. allocated to the periods benefited by the employee's required service.

10. The date on which total compensation expense is calculated in a shares option plan is the date
a. of grant.

11. Which of the following is not a characteristic of a noncompensatory shares purchase plan?
d. All of these are characteristics.

*12. Compensation expense resulting from a performance-type plan is generally
a. determined at the measurement date.

*13. An executive compensation plan in which the executive may receive compensation in cash, shares, or a combination of both, is known as
d. both a performance-type and a stock appreciation rights plan.

*14. The date on which to measure the compensation in a stock appreciation rights plan is the
c. end of each interim period up to the date of exercise.

*15. The payment to executives from a performance-type plan is never based on the
a. market price of the common shares.

16. Which of the following features of preferred shares makes the security more like debt than an equity instrument?
c. Redeemable

17. The value of a perpetual bond is equal to
b. present value of interest alone.

18. The major accounting issue with regards to callable/redeemable preferred shares is
d. whether the shares should be recorded as a liability or an equity.

19. In the proportional method of valuing the debt and warrant portions of a combined sale,
d. the instrument is valued and then a fixed proportion is allocated to each component.

20. Preferred shares that are redeemable/retractable upon the occurrence of a possible future event should be classified as an equity if the triggering event is
c. unlikely to occur.

21. Debt repayable in shares at the option of the issuer should be classified as
a. equity for the principal portion and debt for the interest portion.

22. Retractable preferred shares should be recorded as
c. debt.

23. Convertible bonds may be recorded on issuance by the
d. incremental method or the proportional method.

24. Dividends on term preferred shares, where the shares have been recorded as a liability, should be debited to
a. interest expense.

25. Derivative instruments
b. transfer financial risks.

26. Derivatives exist to help companies
d. manage risks.

27. Credit risk is the risk that
c. one of the parties to the contract will fail to fulfill its obligation and cause the other party loss.

33. A call option is a right to
d. buy the underlying security.

MULTIPLE CHOICE—Computational


Use the following information for questions 41 through 43.

Pat Co. has $3,000,000 of 8% convertible bonds outstanding. Each $1,000 bond is convertible into 30 no par value common shares. The bonds pay interest on January 31 and July 31. On July 31, 2006, the holders of $900,000 bonds exercised the conversion privilege. On that date the market price of the bonds was 105, the market price of the common shares was $36, the carrying value of the common shares was $18 and the Contributed Surplus—Bond Conversion was $450,000. The total unamortized bond premium at the date of conversion was $210,000.

41. Using the book value method, Pat should record as a result of this conversion
d. no gain or loss.

42. Using the book value method, Pat should record as a result of this conversion
c. a credit of $63,000 to Premium on Bonds Payable.

43. On July 31, 2006, $600,000 of the bonds were called at 105 and retired. Pat should record for this transaction
c. a gain of $12,000.

44. On July 1, 2006, an interest payment date, $90,000 of Rush Co. bonds were converted into 1,800 no par value common shares of Rush Co. There is $3,600 unamortized discount on the bonds. When the bonds were issued the equity portion of the bond was valued at $850. Using the book value method, Rush would record
b. an $87,250 increase in Common Shares.

45. Sellmer Corporation had two issues of securities outstanding: common shares and an 8% convertible bond issue in the face amount of $8,000,000. Interest payment dates of the bond issue are June 30 and December 31. The conversion clause in the bond indenture entitles the bondholders to receive forty no par value common shares in exchange for each $1,000 bond. The value of the equity portion of the bond issue is $60,000. On June 30, 2006, the holders of $1,200,000 face value bonds exercised the conversion privilege. The market price of the bonds on that date was $1,100 per bond and the market price of the common shares was $35. The total unamortized bond discount at the date of conversion was $500,000. In applying the book value method, what amount should Sellmer credit to the account Common Shares as a result of this conversion?
b. $1,134,000.

Use the following information for questions 46 through 48.

Wong Corporation issued $6,000,000 of 9%, ten-year convertible bonds on July 1, 2006 at 96.1 plus accrued interest. The bonds were dated April 1, 2006 with interest payable April 1 and October 1. If the bonds had not been convertible, they would have sold for 98 plus accrued interest. Bond discount is amortized semiannually on a straight-line basis. On April 1, 2007, $1,200,000 of these bonds were converted into 500 no par value common shares. Accrued interest was paid in cash at the time of conversion.

46. If "interest payable" were credited when the bonds were issued, what should be the amount of the debit to "interest expense" on October 1, 2006?
d. $143,923.

47. What should be the amount of the unamortized bond discount on April 1, 2007 relating to the bonds converted?
a. $64,246.

48. What was the effective interest rate on the bonds when they were issued?
b. Above 9%

49. In 2005, Olynik, Inc., issued for $103 per share, 20,000 no par value convertible preferred shares. One share of preferred shares can be converted into three shares of Olynik's no par value common shares at the option of the preferred shareholder. In August 2006, all of the preferred shares were converted into common shares. The market value of the common shares at the date of the conversion was $30 per share. What total amount should be credited to Common Shares as a result of the conversion of the preferred shares into common shares?
d. $2,060,000.

50. On December 1, 2006, Horton Company issued at 103, five hundred of its 9%, $1,000 bonds. Attached to each bond was one detachable stock warrant entitling the holder to purchase 10 of Horton's common shares. On December 1, 2006, the market value of the bonds, without the stock warrants, was 95, and the market value of each stock warrant was $50. The amount of the proceeds from the issuance that should be accounted for as the initial carrying value of the bonds payable would be
b. $489,250.

51. On March 1, 2006, Loma Corporation issued $300,000 of 8% nonconvertible bonds at 104, which are due on February 28, 2026. In addition, each $1,000 bond was issued with 25 detachable stock warrants, each of which entitled the bondholder to purchase for $50 one of Loma’s no par vlaue common shares. The bonds without the warrants would normally sell at 95. On March 1, 2006 the fair market value of Loma’s common shares was $40 per share and the fair market value of each warrant was $2.00. What amount should Loma record on March 1, 2006 as contributed surplus from stock warrants?
c. $15,600.

52. During 2006, Becker Company issued at 104 four hundred $1,000 bonds due in ten years. One detachable stock warrant entitling the holder to purchase 15 of Becker’s common shares was attached to each bond. At the date of issuance, the market value of the bonds, without the stock warrants, was quoted at 96. The market value of each detachable warrant was quoted at $40. What amount, if any, of the proceeds from the issuance should be accounted for as part of Becker’s shareholders' equity?
c. $16,640.

53. On April 7, 2006, Wilhelm Corporation sold a $2,000,000 twenty-year, 8 percent bond issue for $2,120,000. Each $1,000 bond has two detachable warrants, each of which permits the purchase of one share of the corporation's no par value common shares for $30. Immediately after the sale of the bonds, the corporation's securities had the following market values:
8% bond without warrants $1,008
Warrants 21
Common shares 28
What accounts should Wilhelm credit to record the sale of the bonds?
c. Bonds Payable $2,000,000
Premium on Bonds Payable 35,200
Contributed Surplus—Stock Warrants 84,800

Use the following information for questions 54 and 55.

On May 1, 2006, Jenks Co. issued $500,000 of 7% bonds at 103, which are due on April 30, 2016. Twenty detachable stock warrants entitling the holder to purchase for $40 one share of Jenks’ no par value common shares were attached to each $1,000 bond. The bonds without the warrants would sell at 96. On May 1, 2006, the fair value of Jenks’ common shares was $35 per share and of the warrants was $2.

54. On May 1, 2006, Jenks should credit Contributed Surplus from Stock Warrants for
c. $20,600.

55. On May 1, 2006, Jenks should record the bonds with a
b. discount of $5,600.

56. On July 1, 2006, Costa Company issued for $1,050,000 a total of 10,000, $7 noncumulative, no par value, preferred shares along with one detachable warrant for each share issued. Each warrant contains a right to purchase one share of Costa no par value common shares for $15 per share. The shares without the warrants would normally sell for $1,025,000. The market price of the rights on July 1, 2006, was $2.50 per right. On October 31, 2006, when the market price of the common shares was $19 per share and the market value of the rights was $3.00 per right, 4,000 rights were exercised. As a result of the exercise of the 4,000 rights and the issuance of the related common shares, what journal entry would Costa make?
b. Cash 60,000
Contributed Surplus—Stock Warrants 10,000
Common Shares 70,000

57. Avans Corp. on January 1, 2003, granted stock options for 50,000 of its no par value common shares to its key employees. The market price of the common shares on that date was $23 per share and the option price was $20. The Black-Scholes option pricing model determines total compensation expense to be $300,000. The options are exercisable beginning January 1, 2006, providing those key employees are still in the employ of Avans at the time the options are exercised. The options expire on January 1, 2007.
On January 1, 2006, when the market price of the shares was $29 per share, all 50,000 options were exercised. The amount of compensation expense Avans should record for 2005 is
c. $100,000.

58. On December 31, 2006, Green Company granted some of its executives options to purchase 45,000 of the company's no par common shares at an option price of $60 per share. The Black-Scholes option pricing model determines total compensation expense to be $900,000. The options become exercisable on January 1, 2007, and represent compensation for executives' past and future services over a three-year period beginning January 1, 2007. What is the impact on Green's total shareholders' equity for the year ended December 31, 2006, as a result of this transaction?
c. $0

59. On June 30, 2003, Stone Corporation granted compensatory stock options for 30,000 of its no par value common shares to certain of its key employees. The market price of the common shares on that date was $36 per share and the option price was $30. The Black-Scholes option pricing model determines total compensation expense to be $360,000. The options are exercisable beginning January 1, 2006, providing those key employees are still in the employ of Stone at the time the options are exercised. The options expire on June 30, 2007.
On January 4, 2006, when the market price of the shares was $42 per share, all 30,000 options were exercised. What should be the amount of compensation expense recorded by Stone Corporation for the calendar year 2005?
b. $144,000.

60. In order to retain certain key executives, Won Corporation granted them incentive stock options on December 31, 2005. 25,000 options were granted at an option price of $35 per share. Market prices of the shares were as follows:
December 31, 2006 $46 per share
December 31, 2007 51 per share
The options were granted as compensation for executives' services to be rendered over a two-year period beginning January 1, 2006. The Black-Scholes option pricing model determines total compensation expense to be $250,000. What amount of compensation expense should Won recognize as a result of this plan for the year ended December 31, 2006?
a. $125,000.

61. Knapp, Inc. had 80,000 treasury shares at December 31, 2005, which it acquired at $11 per share. On June 4, 2006, Knapp issued 40,000 treasury shares to employees who exercised options under Knapp's employee stock option plan. The market value per share was $13 at December 31, 2005, $15 at June 4, 2006, and $18 at December 31, 2006. The stock options had been granted for $12 per share. The cost method is used. What is the balance of the treasury shares on Knapp's balance sheet at December 31, 2006?
c. $440,000.

Use the following information for questions 62 through 64.

On January 1, 2005, Manning, Ltd. established a stock appreciation rights plan for its executives. It entitled them to receive cash at any time during the next four years for the difference between the market price of its common shares and a pre-established price of $20 on 50,000 SARs. Current market prices of the shares are as follows:
January 1, 2005 $35 per share
December 31, 2005 38 per share
December 31, 2006 30 per share
December 31, 2007 33 per share
Compensation expense relating to the plan is to be recorded over a four-year period beginning January 1, 2005.

*62. What amount of compensation expense should Manning recognize for the year ended December 31, 2005?
b. $225,000.

*63. What amount of compensation expense should Manning recognize for the year ended December 31, 2006?
b. $25,000.

*64. On December 31, 2007, 8,000 SARs are exercised by executives. What amount of compensation expense should Manning recognize for the year ended December 31, 2007?
a. $237,500.

65. Wagner Film Corp. issued for $2,000,000, 5-year, 8% bonds with a face value of $2,000,000 and with each $10,000 bond having a warrant to purchase 100 shares at $8.00 each. Similar bonds without the warrant are being issued at 10%. Using the incremental method, what value should be recorded for the warranty?
c. $151,634

66. Pronghorn Inc. issued bonds with warrants for $5,000,000. The bond component has a face value of $5,000,000 and a present value of $4,934,400. The fair value of the warrants is determined to be $220,000. Using the proportional method, how much of the issue price should be allocated to the warrants?
d. 200,000

67. Benfica Technologies Ltd. issued a $500,000, 10%, 5-year bond repayable at its option in either cash or shares for $520,000 cash. Currently, similar bonds have a 6% market rate. Using the incremental method, how much should be recorded as equity?
b. $309,382

68. Abacus International Ltd. issued for $4,000,000, 5-year, 8% convertible bonds with a face value of $4,000,000 and with each bond convertible to 200 shares of Abacus. The current market rate for similar non-convertible bonds is 10%. Using the incremental method, determine the value to be recorded for the conversion option.
d. $303,267


Use the following information for questions 69-72.

On April 1, 2006, Ryoko Investments Corp. purchases a call option for $500, which gives it the right to buy 1,000 shares of Xylon Inc. for $30 each until December 1, 2006. Xylon Inc. shares are currently trading for $29 each. At June 30, 2006, the options are trading at $4,800 and the shares at $32 each. At December 1, 2006, the options expire with no value.

69. The time value of the option at April 1, 2006 is
b. $1,500.

70. The entry to record the call option purchase at April1, 2006 is
a. Investments—Trading 500
Cash 500

71. At June 30, 2006, Ryoko’s quarter end, the adjusting entry would be
c. Investments—Trading 4,300
Gain 4,300

72. At December 1, 2006, Ryoko’s entry would be
d. Loss 4,800
Investments—Trading 4,800

73. On July 5, 2006, Alpha Corp. purchased a call option for speculative purposes for $1,200, giving it the right to buy 1,000 shares of Omega for $20 per share. On August 18, 2006, Omega settles the option for cash at a time when the option value is $6,000. The entry to record the settlement by Alpha is
a. Cash 6,000
Investments—Trading 1,200
Gain 4,800

Use the following information for questions 74 and 75.

On August 5, 2006, Beta Futures Inc. entered into a speculative forward contract to buy 100,000 Chinese RMB for $16,600 Canadian on September 5, 2006. On August 5, 2006, 100,000 RMB can be purchased for $16,000 Canadian.

74. The entry to record the contract on August 5, 2006 is
d. Loss 600
Financial Liability—Derivative Trading 600

75. On September 5, 2006, the RMB is worth $.17 Canadian. The entry to record the settling of the contract is
b. Financial Liability—Derivative Trading 600
Cash 400
Gain 1,000


*76. On October 5, 2006, Active T-shirt Ltd. enters into a forward contract to purchase 10,000 metres of cotton fabric at $1 per metre, good until February 2007. At December 31, 2006, the price for February delivery of cotton fabric has increased to $1.05 per metre. The adjusting entry at December 31, 2006 would be
d. Futures Contract 500
Unrealized Holding Gain 500


DERIVATIONS—Computational

No. Answer Derivation
41. d Conceptual

42. c $210,000 × .30 = $63,000.

43. c [$600,00 + (1/5 × $210,000)] – ($600,000 × 1.05) = $12,000.

44. b $90,000 – $3,600 + $850 = $87,250.

45. b ($1,200,000 ÷ 8,000,000) × $500,000 = $75,000 (unamortized discount)
($1,200,000 ÷ 8,000,000) × $60,000 = $1,900 (cont. surplus)
$1,200,000 – $75,000 + $1,900 = $1,134,000.

46. d $6,000,000 × 96.1% = $5,766,000
$6,000,000 × 98% = $5,880,000
$5,880,000 – $5,766,000 = $114,000 (cont. surplus)
$5,766,000 + ($6,000,000 × .09 × 3/12) = $5,901,000 (cash rec’d)
$6,000,000 + $135,000 + $114,000 – $5,901,000 = $348,000 (bond discount)
($6,000,000 × .09 × 3/12) + ($348,000 × 3/117) = $143,923.

47. a $348,000 × $1,200,000 ÷ $6,000,000 × 108 ÷ 117 = $64,246.

48. b Bonds issued at a discount, market rate > coupon rate.

49. d $103 × 20,000 = $2,060,000.

50. b ($500,000 × .95) + (500 × $50) = $500,000; $500,000 × 1.03 = $515,000
× $515,000 = $489,250.

51. c ($300,000 × .95) + (300 × $25 × 2) = $300,000; $300,000 × 1.04 = $312,000
× $312,000 = $15,600.

52. c ($400,000 × .96) + (400 × $40) = $400,000; $400,000 × 1.04 = $416,000
× $416,000 = $16,640.

53. c (2,000 × $1,008) + (4,000 × $21) = $2,100,000
× $2,120,000 = $2,035,200, bonds: $2,000,000
Premium: $35,200; × $2,120,000 = $84,800.

54. c ($500,000 × .96) + (10,000 × $2) = $500,000;
$500,000 × 1.03 = $515,000
× $515,000 = $20,600.

55. b $500,000 – = $5,600.

56. b Dr. Cash: 4,000 × $15 = $60,000
Dr. Contributed Surplus—Stock Warrants: $25,000 × 4/10 = $10,000
Cr. Common Shares: $60,000 + $10,000 = $70,000.

57. c $300,000 ÷ 3 = $100,000/year.

58. c $900,000 – = $300,000 increase (from the credit to
Compensation Expense).

Surplus—Stock Options). Offset by $300,000 decrease (from the debit to
Compensation Expense).

59. b $360,000 × = $144,000.

60. a $250,000 ÷ 2 = $125,000.

61. c 40,000 × $11 = $440,000.

*62. b ($38 – $20) × 50,000 × .25 = $225,000.

*63. b ($30 – $20) × 50,000 × .5 = $250,000
$250,000 – $225,000 = $25,000.

*64. a ($33 – $20) × 50,000 × .75 = $487,500
$487,500 – $250,000 = $237,500.

65. c PV of $2,000,000 @10%, 5 years = $1,241,840
PV of $160,000/year @10%, 5 years = 606,526
$2,000,000 less Total $1,848,366 = $151,634 value of warrant.

66. d Bonds $4,934,400 96%
Warrants 205,600 4%
Total $5,140,000 100%
$5,000,000 issue price × 4% = $200,000.

67. b PV of interest: $50,000, 5 years @6% = $210,618
$520,000 total – $210,618 = $309,382 value of principal.

68. d PV $4,000,000, 5 years,10% = $2,483,680
PV $320,000/year, 5 years, 10% = 1,213,053
Total $3,696,733
Issue price of $4,000,000 – $3,696,733 = $303,267 value of option.

69. b Intrinsic value = ($29 – $30) × 1,000 = –$1,000
$500 – (–$1,000) = $1,500 time value.

70. a Conceptual.

71. c $4,800 fair value less $500 recorded cost = $4,300 gain.

72. d $0 – $4,800 = $4,800 loss.

73. a $6,000 – $1,200 = $4,800 gain.

74. d Agreed payment $16,600 – $16,000 current cost = $600 loss.

75. b 100,000 RMB @.$17 = $17,000
$17,000 – $16,600 settlement amount = $400 gain overall
$400 gain + $600 loss previously recorded = $1,000 gain to record.

76. d ($1.05 – $1.00) × 10,000 = $500 gain.