Convertible Debt at Time of Issuance

E16-1 (part 1)
Cash
Bond discount
Bonds payable
9,900,000
100,000
Bond issue costs
Cash
70,000
10,000,000
70,000
Time of “Normal” Conversion
• Text (p. 797)
• Carrying amount of bonds (book value):
Bonds payable
Bond premium
1,000
50
1,050
Time of “Normal” Conversion
Bonds payable
Premium on bonds payable
1,000
50
Time of “Normal” Conversion
Bonds payable
1,000
Premium on bonds payable
50
Common stock (par value)
APIC (1,050 – 100)
100
950
Induced Conversions
• Involves a “sweetner”
• E16-1 (part 3)
Induced Conversions
Book value of bonds:
Bonds payable
Discount on bonds payable
10,000,000
55,000
9,945,000
1,000,000
8,945,000
9,945,000
Par value of stock
APIC
Debt conversion expense
Bonds payable
Discount on bonds payable
Common stock
APIC
Cash
75,000
10,000,000
55,000
1,000,000
8,945,000
75,000
Convertible Preferred Stock
 Is equity - unless mandatory redeemable
 Conversion is an equity transaction -- no
gain or loss recognized
 Book value of preferred used to record
conversion
Conv. Preferred Stock – Text P. 798
Book value of preferred:
Preferred
APIC – preferred
Preferred stock
APIC – preferred
1,000
200
1,200
1000
200
Conv. Preferred Stock – Text P. 798
Book value of preferred:
Preferred
APIC – preferred
Preferred stock
APIC – preferred
Common stock (1,000 x $2 par)
1,000
200
1,200
1000
200
2,000
Conv. Preferred Stock – Text P. 798
Book value of preferred:
Preferred
APIC – preferred
Preferred stock
APIC – preferred
Retained earnings
Common stock (1,000 x $2 par)
1,000
200
1,200
1000
200
800
2,000
Conv. Preferred Stock – Text P. 781
What if convertible into 400 shares of common?
Book value of preferred:
Preferred
APIC – preferred
Preferred stock
APIC – preferred
1,000
200
1,200
1000
200
Conv. Preferred Stock – Text P. 781
What if convertible into 400 shares of common?
Book value of preferred:
Preferred
APIC – preferred
Preferred stock
APIC – preferred
Common stock (400 x $2 par)
1,000
200
1,200
1000
200
800
Conv. Preferred Stock – Text P. 781
What if convertible into 400 shares of common?
Book value of preferred:
Preferred
APIC – preferred
Preferred stock
APIC – preferred
Common stock (400 x $2 par)
APIC – common
1,000
200
1,200
1000
200
800
400
Stock Warrants
 Entitle holder to acquire additional shares
• within a specified period
• at a specified price
Typical uses
• “Equity kicker”
• Evidence of preemptive right of existing
stockholders
• Stock-based compensation for executives (stock
options)
Stock Warrants (cont.)
 Detachable
• Proportional method (if FV of both debt and
warrant determinable)
• Incremental method (if FV of both not
determinable)
Nondetachable
• No part of proceeds allocated to warrants
See text examples pp. 800-801
Stock Warrants (cont.)
 Allocated to warrants:
300,000/10,200,000 x 10,000,000 =
 Allocated to bonds:
9,900,000/10,200,000 x 10,000,000 =
Cash
Discount on bonds payable
Bonds payable
Cash
APIC - stock warrants
294,118
9,705,882
10,000,000
9,705,882
294,118
10,000,000
294,118
294,118
Stock Warrants (cont.)
 What if proceeds = $9,700,000?
 Allocated to warrants:
300,000/10,200,000 x 9,700,000 =
 Allocated to bonds:
9,900,000/10,200,000 x 9,700,000 =
Cash
Discount on bonds payable
Bonds payable
Cash
APIC - stock warrants
285,294
9,414,706
9,700,000
9,414,706
585,294
10,000,000
285,294
285,294
Stock Compensation Plans

Stock option plans:
• incentive plans [qualified for tax purposes]
• non-qualified plans


Stock appreciation rights
Performance plans
Stock Options - Important Dates
Work
start date
Grant
date
Vesting
date
Exercise
date
Expiration
date
Options
are
granted to
employee
Date option
vests –
employee
must do
nothing else
Employee
exercises
options
Unexercised
options
expire
Stock Option Plans

Accounting method
• Now required - fair value method (SFAS
123R)
• Previously required - intrinsic value
method (APBO 25)
Fair Value Method
Total compensation cost (TCC)
• Fair value at grant date of options
expected to vest
Allocate TCC over service period
See page 806
Stock Appreciation Rights [SARs]



SARs are designed to mitigate employee’s cash flow
problems in non-qualified plans
Employee gets a right to receive any appreciation in
share value at exercise date equal to market price
less a pre-established amount
Employee receives cash or stock only for the
appreciation.
Stock Appreciation Rights (SARs): Example










Given:
SAR program is established: January 1, 2010
SAR exercise period: any time next five years
Pre-established price per SAR: $10
Number of SARs granted: 10,000
Market prices of the stock:
Dec 31, 10: $ 3;
Dec 31, 11: $7; Dec 31, 12: $ 5.
Service period: 2 years (2010 - 2011)
The SARs are held for 3 years and then exercised.
Determine the compensation expense for 2010, 11, and 12.
Stock Appreciation Rights (SARs): Entries
Debit
Dec 31, 2010
Dec 31, 2011
Dec 31, 2012
Dec 31, 2012
Compensation Expense
Liability for SARs
$15,000
Compensation Expense
Liability for SARs
$55,000
Credit
$15,000
Liability for SARs
$20,000
Compensation Expense
Liability for SARs
$50,000
Cash
(SARs exercised end of the third year)
$55,000
$20,000
$50,000