Owners’ Equity
RCJ Chapter 15
Key Issues
1.
Statement of O/E
2.
O/E accounts
3.
O/E events
4.
Convertible debt
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2
Statement of Owners’ Equity
(link to SCF, financing section)
Shows all events affecting common O/E accounts (entry is O/E side of event JE)
ex. Stock issuances, repos, option exercises, NI, dividends, conversions, etc.
events # shares* Par
1. ex. Repo
-
APC
Common O/E accounts _________________
TreasStock Acc’dCompInc
R/E
Total
DR
DR
2. ex. Option +
exercise
CR
CR
(or CR to Treasury Stock)
CR
3. ex. Conversion
CR
CR
(or CR to Treasury Stock)
CR
+
4. ex. NI
CR
CR
5. ex. Div
DR
DR
* #’shares in table show the effect of the event on the specific O/E account (CR is + and DR is -)
Ex. P15-13,14
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Convertible Debt
Def: bonds with an option attached


option = right to convert bonds into common stock @ conversion
price for a certain period
because of conversion option, convertible bonds have yields <
straight bonds

i.e., bondholder gives up some guaranteed interest for the
possibility of stock price appreciation
Journal entries
1. issuance: ignore conversion feature, as if its value were zero
(just like IV method for options)
DR Cash
CR B/P
2. interest payment: also just like straight bond
DR Interest expense
CR
Cash
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Convertible Bonds (cont’d)
3. Conversion: 2 methods: market value method and book value
method.
market value method
book value method
DR
CR
DR
CR
B/P (BV) C/S (MV @ conversion)
B/P (BV)
C/S (BV)
Loss
 MV > BV or no one would convert
Ex. P15-3
Key financial statement analysis implications:
1. difficulty to estimate future cash outflows, because of the probability
of conversion, and
2. recorded interest expense understates the true cost of debt
Paul Zarowin
5