Bonds: Convertible Bonds, Detachable Warrants, Extinguish Debts Flashcards Preview

FAR CPA Review - (Becker, Roger, Wiley CPA Excel, NINJA) > Bonds: Convertible Bonds, Detachable Warrants, Extinguish Debts > Flashcards

Flashcards in Bonds: Convertible Bonds, Detachable Warrants, Extinguish Debts Deck (14):
1

Convertible bonds - what are they?

What are the two types?

Convertible bonds: convert bonds in to shares of common stock.

Two types of convertible bonds:
(1) Detachable warrants
(2) Nondetachable warrants

2

What are nondetachable warrants?

What are Detachable warrants?

Nondetachable warrants = convert the ENTIRE BOND into Common stock. Other words, surrender the entire bond to be converted into common stock

Detachable warrants = Separate from bonds. can be bought and sold separately from the bonds themselves.

3

Conversion of convertible bonds (nondetachable warrants):

what are the two methods to convert these?

(1) Book value method: Convert bonds to common stock where the common stock is measured at bonds carry value (Common stock (at conversion) = Bond's carry value)

Book value method: NO RECOGNIZE gain or loss

(2) Market value method: At conversion, Common stock is measured at the Market value of Stock or Market value on bonds.

In market method: Remove the bonds liability (debit bond payable and Debit any Premium on bond payable).

Market method: also RECOGNIZE any Gain or Loss.

4

Convertible bonds: Book value method

What are journal entries to
(a) Issue (sell) a Convertible bond (purchase convertible bond)
(b) Convert the bond into commonstock

Journal entries: Book value method

(a) Borrower: borrows convertible bond (buys the convertible bond):

Cash $1,081,105
Bonds Payable $1,000,000 (face value)
Premium on bond payable 81,105

Note: bonds payable = 1,000 bonds x $1,000 face per bond.

(b) Converting the convertible bond into common stock

Example: Convert half
Bond Payable (B/P) 500,000 ($1,000,000 / 2)
Premium on B/P 40,552 (81,105 / 2)
Common stock 100,000 ($200 par x 500 bonds)
APIC 440,552 (plug)

Note:
* Debit Bond Payable and Debit Premium to remove them.
* Credit C/S and APIC to create these accounts.
* APIC = 500,000 B/P + 40,552 premium - 100,000 c/s
= 440,552 (plug)


Example: Full conversion
Bond Payable $1,000,000
Premium on bond 81,105
Common stock 200,000 ($200 x 1,000 bonds)
APIC 881,105 (plug)


* Debit Bond Payable and Debit Premium to remove them.
* Credit C/S and APIC to create these accounts.
* APIC = 500,000 B/P + 40,552 premium - 100,000 c/s
= 440,552 (plug)

5

Convertible bonds: Market value method

What are journal entries to
(a) Borrow a Convertible bond (issue convertible bond)
(b) Convert the bond into common stock

Journal entries: Book value method

(a) Borrower: borrows convertible bond (buys the convertible bond):

Cash $1,081,105
Bonds Payable $1,000,000 (face value)
Premium on bond payable 81,105

Note: bonds payable = 1,000 bonds x $1,000 face per bond.

(b) Converting the convertible bond into common stock

Example: Full conversion
Bond Payable $1,000,000
Premium on bond 81,105
Loss on conversion 118,895 (plug)
Common stock 200,000 ($200 par x 1,000 bonds)
APIC 1,000,000
($1200 FV - $200 par x 1000 bonds)


* Debit Bond Payable and Debit Premium to remove them.
* Debit loss on conversion (plug) = Stock market value - Bonds book value.
Or: $1,200,000 FV stock - $1,081,105 bond book value
= 118,895

* Credit C/S and APIC to create these accounts.

6

Convertible bonds: Bonds with detachable warrants (stock rights)

How are these handled?

What is the journal entry when issuing a Bond with detachable warrant?

Detachable warrants are handled separately from the bond.
How to do this: Assigned the value to a separate conversion feature is its fair value of issue. Allocate based on Fair value to the Bonds and to the APIC-Warrants

Journal entries:
Cash $xxx
Bonds payable $xxxx
APIC - warrants $xxx

7

Two methods to treat bonds with detachable warrants.

Warrants only method: Know only Fair Value (FV) on Warrants. Do not know fair value on bonds.

Allocate first the Fair value to the Detachable warrants (security). Then allocate remaining to the bonds payable.


Markets only method: Know Fair value (FV) on both Detachable Warrants and bonds payable. Then allocate total bond price in proportion to fair values.

8

Detachable warrants (warrants only method - only know the fair value on the warrants only)

Journal entry:
(a) At first day in buying the bond with detachable warrants
(b) When Exercise the detachable warrants

(a) First day to buy bond with warrants.

Cash $1,081,105 (Purchase price on bond)
Discount on B/P 68,895 (plug)
Bonds Payable $1,000,000 ($1000 x 1000 bonds)
APIC - Warrants 150,000
($150 FV warrant x 1000)

Note:
* (Plug) Discount on B/P:
1,000,000 bonds payable + 150,000 APIC warrants - $1,081,105 purchase price on bonds = $68,895

(b) Exercise detachable warrants

Example: Half exercise (here focus only on Warrants and C/S and APIC)

Cash 625,000
(500 bonds x $1250 exchange value for 1 share c/s)
APIC - Warrants 75,000 ($150,000 FV / 2)
Common stock 100,000 ($200 par x 500 bonds)
APIC (plug) 600,000 plug

Then, other half expired
APIC - warrants $75,000
APIC 75,000


Example: Full exercise
Cash 1,250,000
APIC - Warrants 150,000
Common Stock 200,000
APIC 1,200,000 (plug)

Note: for detachable warrants, there is no Journal entries for Bonds Payable when exercise the Detachable warrants.

9

Detachable warrants (market value method)

Journal entry:
(a) At first day in issuing (sell) the bond with detachable warrants
(b) When Exercise the detachable warrants

(a) First day buy bond with detachable stock warrants

Cash $1,081,105 (purchase price)
Discount on bonds payable 48,628 (plug)
Bonds payable 1,000,000 ($1000 x 1000)
APIC - Warrants 129,733*

* APIC warrants =
$1,081,000 purchase price on bonds
x [ $150,000 FV warrants / (1,100,000 bonds FV + 150,000 FV warrants)

(b) Exercise all warrants
Cash $1,250,000 total market value for bonds and warrant
APIC warrants 129,733
Common stock 200,000 ($200 par x 1000 bonds)
APIC 1,179,733 (plug)

10

Extinguish bond

What is the formula to report gain or loss on extinguish the bond (get rid of bond)?

How to calculate the cash paid a.k.a. Reacquistion price?

How to calculate net book value?

Cash paid (or reacquistion price)
- Net book value
---------------------
= (Gain) or Loss

Reacquistion price (cash paid):
e.g. $100,000 x 1.02 or $100,000 x 0.95

Net book value =
Bonds face value
- Issue costs
- Unamortized Discount
+ Unamortized premium

11

When Net book value of bond is less than Cash paid (reacaquistion paid), you get

Gain or loss?

NBV less than Cash paid (re-acquistion price)

= loss



When NBV on bond is (less than

12

When Net book value of bond is greater than Cash paid (reacaquistion paid), you get

Gain or loss?

NBV greater than Cash paid (re-acquisition price)

= gain


NBV on bond > cash paid = gain

Because you paid less than what is owe now before eliminating the bond debt.

13

IFRS:

What are the two methods allowed to recognize bonds?

Amortized cost or

Fair value through profit or loss (with gain or loss reported on income statement)

14

Under IFRS, issued convertible bonds are separated into debt and equity componetns with liability component reocred at fair value and Residual ssigned to equity component.

True or false

True

Under IFRS, convertible bonds debt component is measured separately from the the equity component. Measure the bond component the same way to report detachable warrants.

This is done via:
Actual proceeds receive
- Bond liability fair value
----------
= Difference allocated as component of equity

Example:

Face value of bonds:
2000 x $1000 per bond = $2,000,000

PV $1 on principle: $2,000,000 x 0.68058 = $1,361,160

PV Ordinary annuity for Interest:
$120,000 payments x 3.99271 = $479,125

0.06 x $2,000,000 = $120,000 interest

Value of liability: $1,361,160 + 479,125 = $1,840,285

Equity component:
$2,000,000 face value of bond
- 1,840,285 proceeds received
--------
= $159,715 to equity component

Journal entries:
Cash 2,000,000
Bonds payable 1,840,285
Equity - conversion option 159,715

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