Convertible Bonds, VIE, & Business Combinations Flashcards Preview

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Flashcards in Convertible Bonds, VIE, & Business Combinations Deck (20):
1

On July 1, year 1, after recording interest and amortization, York Co. converted $1,000,000 of its 12% convertible bonds into 50,000 shares of $1 par value common stock.
On the conversion date, the carrying amount of the bonds was $1,300,000, the market value of the bonds was $1,400,000, and York's common stock was publicly trading at $30 per share.

Using the book value method, what amount of additional paid-in capital should York record as a result of the conversion?

A. $950,000
B. $1,250,000
C. $1,350,000
D. $1,500,000

B. $1,250,000

* Market value of bonds and Interest rates aren't used in this problem

A journal entry illustrates how the answer can be derived:
Bonds payable
1,000,000
Premium on bonds payable
300,000
Common stock 50,000($1)
50,000
Additional paid-in capital
1,250,000
Under the book value method, the book value of the bonds is transferred to the common stock accounts. Market values are not used in the recording. The common stock is recorded at par with the remaining book value allocated to the additional paid-in capital.

2

Which of the following is generally associated with the terms of convertible debt securities?
A. An interest rate that is lower than nonconvertible debt.
B. An initial conversion price that is less than the market value of the common stock at time of issuance.
C. A non-callable feature
D. A feature to subordinate the security to nonconvertible debt

A. An interest rate that is lower than nonconvertible debt.

Investors of convertible debt receive the security of debt (guaranteed principal and interest) plus the option of converting to stock if the value of the stock has appreciated.

This conversion feature entices investors to accept a lower interest rate than would be given with a non-convertible debt issue.

3

On June 30, year 1, Hamm Corp. had the face amount of $2,000,000 outstanding in 8% convertible bonds maturing on June 30, year 5. Interest is payable on June 30 and December 31.
Each $1,000 bond is convertible into 40 shares of Hamm's $20 par common stock. After amortization through June 30, year 1, the unamortized balance in the premium on bonds payable account was $50,000.

On June 30, year 1, all the bonds were converted when Hamm's common stock had a market price of $30 per share.

Under the book value method, what amount should Hamm credit to additional paid-in capital in recording the conversion?

A. $350,000
B. $400,000
C. $450,000
D. $800,000

C. $450,000

1.. Bonds Payable 2,000,000
2. Bonds Premium Payable 50,000
3. Common Stock (2,000 *40*20) 1,600,000
4. Additional Paid in Cap (plug) 450,000

CPA:

The journal entry under the book value method, which simply transfers the book value of the convertible bonds to owners' equity accounts (and does not use the market value of the stock to measure the new owners' equity accounts), is as follows:

Convertible bonds payable 2,000,000
Premium on convertible bonds payable 50,000
Common stock (2,000 bonds)($20 par)(40 shares/bond) 1,600,000
Additional paid in capital, common stock 450,000
The entry closes the bond-related accounts, and opens the new owners' equity accounts related to the stock issued on conversion. The common stock account represents the par value of the newly issued shares, and the additional paid-in capital represents the excess of the book value of the bonds on the date of conversion, over the par value of stock issued. The market value of the stock is not used in this entry.

4

On January 2, year 3, Chard Co. issued 10-year convertible bonds at 105. During year 6, these bonds were converted into common stock having an aggregate par value equal to the total face amount of the bonds. At conversion, the market price of Chard's common stock was 50 percent above its par value.
Depending on whether the book value method or the market value method was used, Chard would recognize gains or losses on conversion when using the

Book value method Market value method
Either gain or loss Gain
Either gain or loss Loss
Neither gain nor loss Loss
Neither gain nor loss Gain

Book value method Market value method
Neither gain nor loss Loss

Under the book value method, the book value of the bonds converted is transferred to the common stock account and additional paid-in capital. No gain or loss is recorded.

The market value of the stock issued on conversion is not used in the recording of the stock.

(WHEN CONVERTED, STOCK AND BONDS HAD EQUAL VALUE)
Under the market value method, the stock issued is recorded at its market value. The bonds were issued at a small premium, a portion of which has been amortized. The stock issued has an aggregate par equal to the face value of the bonds.

(The stock MK Value went up, exceeding CV of the bond)
The stock's market value is much higher than its par value. Thus, the bond carrying value is considerably less than the market value of the stock issued according to the information in the question.

(Causing a loss to be recorded because of the C/S value exceeding BV of the bonds)
Therefore, the recorded value of the common stock and additional paid-in capital of the stock issued exceeds the book value of the bonds, causing a loss to be recorded

5

On January 2, year 1, Chard Co. issued 10-year convertible bonds at 105. During year 4, these bonds were converted into common stock having an aggregate par value equal to the total face amount of the bonds.
At conversion, the market price of Chard's common stock was 50 percent above its par value.
On January 2, year 1, cash proceeds from the issuance of the convertible bonds should be reported as

A. Contributed capital for the entire proceeds.
B. Contributed capital for the portion of the proceeds attributable to the conversion feature and as a liability for the balance.
C. A liability for the face amount of the bonds and contributed capital for the premium over the face amount
D. A liability for the entire proceeds

D. A liability for the entire proceeds

There is no method of objectively determining the value of the conversion feature for a convertible bond. The conversion feature is not separable as is the case with detachable stock warrants.
Thus, the entire proceeds are allocated to the bond liability, which in this case includes a premium.

6

On January 1, Stunt Corp. had outstanding convertible bonds with a face value of $1,000,000 and an unamortized discount of $100,000. On that date, the bonds were converted into 100,000 shares of $1 par stock. The market value on the date of conversion was $12 per share. The transaction will be accounted for with the book value method. By what amount will Stunt's stockholders' equity increase as a result of the bond conversion?

A.
$100,000

B.
$900,000

C.
$1,000,000

D.
$1,200,000

Bond Payable 1,000,000
Armortized Disc. 100,000
CS 100,000 - SHE
additional P.C 800,000 -SHE

B. $900,000

7

On March 31, year 1, Ashley, Inc.'s bondholders exchanged their convertible bonds for common stock. The carrying amount of these bonds on Ashley's books was less than the market value but greater than the par value of the common stock issued.
If Ashley used the book value method of accounting for the conversion, which of the following statements is correct for an effect of this conversion?

A. Stockholders' equity is increased.
B. Additional paid-in capital is decreased.
C. Retained earnings is increased.
D. A loss is recognized


A. Stockholders' equity is increased.

When bonds are converted to stock and accounted for by the book value method, the owners' equity is increased by the book value of the bonds.
There is no gain or loss because the book value of the bonds is simply transferred to the stock accounts. Common stock, and additional paid in capital are increased if necessary. If the total par of common stock issued exceeds the book value of the bonds, then retained earnings is decreased. Retained earnings can never be increased on conversion.

8

Which of the following statements characterizes convertible debt?

A.
The holder of the debt must be repaid with shares of the issuer's stock.

B.
No value is assigned to the conversion feature when convertible debt is issued.

C.
The transaction should be recorded as the issuance of stock.

D.
The issuer's stock price is less than market value when the debt is converted.

B.
No value is assigned to the conversion feature when convertible debt is issued.

In contrast to stock issued with detachable warrants, bonds convertible to stock are recorded the same way as nonconvertible bonds.

The conversion feature is not separable at the issue date; there is no known market value for the conversion feature.

Therefore, no value is assigned to the conversion feature at issuance.

9

Which of the following legal forms of business combination will result in the need to prepare consolidated financial statements?

Merger Acquisition Consolidation
Yes Yes Yes
Yes Yes No
No No Yes
No Yes No

Merger Acquisition Consolidation
No Yes No

Only an acquisition form of business combination will require the preparation of consolidated financial statements. In the merger and consolidation forms of business combination, only one firm will remain after the combination. Therefore, there will not be two (or more) sets of financial statements to consolidate.

10

Which one of the following is not a characteristic of a variable-interest entity?
A. A variable-interest entity is thinly capitalized.
B. The equity holders in a variable-interest entity control the entity.
C. The risks and rewards associated with a variable-interest entity mostly accrue to the variable-interest holders.
D. The value of a variable-interest entity depends on the net asset value of the variable-interest entity.

B. The equity holders in a variable-interest entity control the entity.


The equity holders in a variable-interest entity do not control the entity. Control of the activities and decision-making in a variable-interest entity generally resides with the variable-interest holders (not the equity holders) as established by agreement or other instrument.

11

Parco has the following three subsidiaries: Finco, Serco, and Euroco. Finco is a 100% owned finance subsidiary. Serco is an 80% owned service company. Euroco is a 100% owned foreign subsidiary that conducts operations in Western Europe. Which one of the following is the most likely number of entities, including Parco, to be included in Parco's consolidated financial statements?
A. One.
B. Two.
C. Three.
D. Four.

D. Four.

The consolidated statements would include not only Parco, but also all three of its subsidiaries, for a total of four.

12

Which of the following statements concerning the primary beneficiary of a variable-interest entity is/are correct?
I. The primary beneficiary has the ability to direct the most significant economic activities of the variable-interest entity.

II. Only one entity can be the primary beneficiary of a variable-interest entity.

III. The investor that has the greatest equity ownership in a variable-interest entity will be the primary beneficiary of the entity.

A. I only.
B. I and II only.
C. II and III only.
D. I, II, and III.

B. I and II only.

Both Statement I and Statement II are correct; Statement III is not correct.

By definition, the primary beneficiary of a variable-interest entity is the entity that is able to direct the most significant economic activities of the variable-interest entity (Statement I).

Only one entity can be the primary beneficiary of a variable-interest entity, because only one entity will have the ability to direct the activities of the variable-interest entity that most significantly impacts its economic performance (Statement II).

13

Key Corp. issued 1,000 shares of its nonvoting preferred stock for all of Lev Corp.'s outstanding common stock. On the date of the transaction, Key's nonvoting preferred stock had a market value of $100 per share, and Lev's tangible net assets had a book value of $60,000. In addition, Key issued 100 shares of its nonvoting preferred stock to an individual as a finder's fee for arranging the transaction. As a result of this business combination capital transaction, Key's total net assets would increase by:
A. $-0-
B. $60,000
C. $100,000
D. $110,000

C. $100,000

Net assets would increase by $100,000 as a result of Key issuing 1,000 shares of preferred stock with a market value of $100 per share (1,000 shares x $100 = $100,000).

The $10,000 finder's fee (100 shares x $100 per share = $10,000) would be expensed in the period incurred, not capitalized as part of the cost of the combination.

Thus, net assets would increase by $100,000.

14

Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair market value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were:
Sea Shell Total
Common stock, at par $100,000 $200,000 $300,000
Additional paid-in capital 50,000 75,000 125,000
Retained Earnings 22,500 47,500 70,000
Totals $172,500 $322,500 $495,000
Which of the following is the balance in Seashell's additional paid-in capital account immediately following its issuing common stock to effect the consolidation?

A. $-0-
B. $50,000
C. $125,000
D. $245,000

25000*10=250,000

Total SHE =495

495-250=295

D. $245,000


Since Seashell's stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell's stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the fair value of the stock issued is equal to the fair value (and book value) of the net assets acquired (i.e., A - L = SE), or $495,000. The par value of the stock issued is $250,000 (25,000 x $10). Therefore, additional paid-in capital is $495,000 - $250,000 = $245,000.

15

On August 31, 2005, Wood Corp. issued 100,000 shares of its $20 par value common stock for the net assets of Pine, Inc. in a business combination accounted for by the acquisition method. The market value of Wood's common stock on August 31 was $36 per share. Wood paid a fee of $160,000 to the consultant who arranged this acquisition. Costs of registering and issuing the equity securities amounted to $80,000. No goodwill was involved in the purchase.
What should Wood capitalize as the cost of acquiring Pine's net assets?

A. $3,600,000
B. $3,680,000
C. $3,760,000
D. $3,840,000

A. $3,600,000

The cost of acquiring a company includes all cash and other assets distributed, liabilities incurred, and equity shares issued, all at fair value. Direct costs of carrying out a combination (such as accounting, legal, consulting, and finders' fees) are expensed in the period incurred; they are not included as part of the acquired entity. The cost of registering and issuing securities used to effect a business combination are charged against the fair value of the securities issued and, for equity securities, serve to reduce the amount of additional paid-in capital recognized. Thus, this correct answer ($3,600,000) was computed as 100,000 shares issued x $36 per share (fair market value) = $3,600,000. The $160,000 fees paid to a consultant would have been expensed, and the $80,000 cost of registering and issuing the common stock would have reduced the amount recognized from the sale of the stock.

16

Plant Company acquired controlling interest in Seed Company in a legal acquisition. Which one of the following could not be part of the entry to record the acquisition?
A. Debit: Investment in Seed Company.
B. Debit: Goodwill.
C. Credit: Cash
D. Credit: Common stock

B. Debit: Goodwill.

The entry that Plant will make to record its legal acquisition of Seed cannot include a debit to Goodwill. The entry Plant makes will debit (only) the Investment account and credit whatever form(s) of consideration is given (e.g., Cash, Bonds Payable, Common Stock, etc.). Goodwill cannot be debited at the time of the acquisition, though it may be recognized at the time of consolidation

17

Pine Company acquired all of the assets and liabilities of Straw Company for cash in a legal merger. Which one of the following would not be recognized by Pine on its books in recording the business combination?
A. Accounts receivable.
B. Investment in Straw.
C. Intangible asset - Patent.
D. Accounts payable.

B. Investment in Straw.

Pine will not recognize on its books an investment in Straw. Because the business combination is a legal merger, Pine recognizes on its books almost all of Straw's assets and liabilities, not an investment in Straw. There can be no investment in Straw, because Straw will cease to exist.

18

Sayon Co. issues 200,000 shares of $5 par value common stock to acquire Trask Co. in an acquisition-business combination. The market value of Sayon's common stock is $12 per share. Legal and consulting fees incurred in relation to the acquisition are $110,000. Registration and issuance costs for the common stock are $35,000. What should be recorded in Sayon's additional paid-in capital account for this business combination?
A. $1,545,000
B. $1,400,000
C. $1,365,000
D. $1,255,000

C. $1,365,000

12-5=7
7*200,000= 1,400,000(total paid)-35,000 (cost of merger)=1,365,000 ( additional paid in capital)

The calculation is:
Fair value (200,000 sh. x $12/sh.) $2,400,000
Par value (200,000 sh. x $5/sh) (1,000,000)
Gross additional paid-in capital $1,400,000
Less: Registration and issuance costs 35,000
Net additional paid-in capital $1,365,000
The legal and consulting fees ($110,000) were paid in cash and would be expensed in the period incurred. The registration and issuance costs of the common stock are properly deducted from the additional paid-in capital derived from the issuance of the stock.

19

Company L acquired all of the outstanding common stock of Company M in exchange for cash. The acquisition price exceeds the fair value of net assets acquired. How should Company L determine the amounts to be reported for the plant and equipment and long-term debt acquired from Company M?
Plant and Equipment Long-Term Debt
Fair Value M's Carrying Amount
Fair Value Fair Value
M's Carrying Amount Fair Value
M's Carrying Amount M's Carrying Amount

Fair Value Fair Value

When the required acquisition method of accounting is used to record a business combination, all acquired assets and liabilities should be reported at fair value. Therefore, both plant and equipment and long-term debt should be reported at fair value.

20

Seashell Corp. was organized to consolidate Sea Company and Shell Company in a business combination. Seashell issued 25,000 shares of its newly authorized $10 par value common stock in exchange for all of the outstanding common stock of Sea and Shell. At the time of the consolidation, the fair market value of Sea's and Shell's assets and liabilities are equal to their book values. The shareholders' equity accounts of Sea and Shell on the date of the consolidation were:
Sea Shell Total
Common stock, at par $100,000 $200,000 $300,000
Additional paid-in capital 50,000 75,000 125,000
Retained Earnings 22,500 47,500 70,000
Totals $172,500 $322,500 $495,000
Which one of the following is the amount of goodwill Seashell would recognize upon issuing its common stock to effect the consolidation?

A. $-0-
B. $50,000
C. $195,000
D. $245,000

A. $-0-

Since Seashell's stock is newly issued to effect the consolidation, it has no prior market value. In the absence of a market value, the fair value of Seashell's stock is determined by the fair value of the net assets acquired in the consolidation. Therefore, the consideration given (common stock issued) is equal to the fair value of net assets acquired, and no goodwill is recognized.