Chapter 13 Current Liabilities, Contingencies

Liabilities: Probable future sacrifices of economic benefits due

to present obligations of a particular entity arising from past
transactions or events
Debts
A pension plan: Liability?
A non-cancelable lease contract: Liability?
Expected future losses from possible accidents: Liability?
Classification: Current or Non-current
Measurement: Present value
Current Liabilities: payable within one year or one operating
cycle, whichever is longer
Accounts payable (Dividends, Taxes, Interest payable)
Short-term notes payable
Accrued liabilities: incurred but not yet paid expenses
Deposits and Advances from customers
Unearned revenues (Airline, Hotel, Magazine, Service)
Current portion of long-term debt
Short-term obligations expected to be refinanced are non-current
if the firm has the intention and ability to refinance.

Loss Contingencies (Gain contingencies are not accrued.)

If probable and reasonably estimable: Accrue;
If reasonably possible but not estimable: Simply disclose the
existence
Manufacturers warranty (given with the purchase): Record
warranty expense and estimated warranty liability at the time of
sales if warranty is an important part of sale (matching).
(e.g.) During December 2014, 200 TVs were sold for $160,000
with one-year warranty. The estimated future warranty repair
cost for these TVs is $20,000. During 2015, the actual warranty
cost for TVs sold during December 2014 was $1,200.
In December 2014
Cash
Sales

160,000
160,000

Warranty exp 20,000

Warranty liab 20,000
In 2015
Warranty liab 1,200
Cash, payroll 1,200

Extended warranty (sold separately): Unearned revenue when

sold and becomes revenue as warranty period (partially) passes;
warranty costs are expensed as incurred

Premium, frequent flier miles: Expense when given

(Do it like manufacturers warranty)

Litigation: Record litigation expense and litigation liability

when loss is probable and estimable

[When an estimate changes, adjust based on the new estimate.]

Chapter 15 Stockholders Equity

SE = Net Assets (AL): Residual interest
No valuation problem for SE
Components of SE:
Paid-in capital: invested by (potential) shareholders
Common and Preferred stock (par)
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (AOCI)
[Comprehensive income (CI) = NI + OCI,
total nonowner change in equity, net of taxes]
Unrealized holding gain/loss on afs securities (Ch 17)
Unrecognized g/l and psc on pensions (Ch 20)
Deferred gain/loss on derivatives (Appendix 17A)
Treasury stock (negative SE)
Income statement

Balance sheet

Net income

Retained earnings

Other comp income

Accumulated OCI

Comp income

(1) Issuance of stock

(e.g.) Company issues 1 million common shares with par value

$1.00 for $10,000,000 cash (net of issue costs).
Cash
10M
Common stock (par)
1M
Paid-in capital
9M
In excess of par
If a non-monetary asset is received, use the fair value.
(of either asset or stock)
Do similarly for Preferred stock
(2) Retirement and Treasury stock
Purpose of repurchase of common stock:
Effective cash distribution
Increase EPS and stock price
Compensation
Merger related
Treasury stock:
Not an asset but negative SE
Issued but not outstanding (appears at the end of SE with
amount in parenthesis)

Cost methos of recording Treasury stock trnsactions

Company repurchases 1M common shares for $13M.

Company sold the 1M treasury shares for $14M ($10M). At that

time, the Paid-in capital from TS a/c had a balance of $10M.

[The cost of treasury stock is determined using either FIFO,

average cost, or specific identification method.]

Dividends
(A) Cash dividends
When declared:
When paid:
(B) Property dividends (e.g., stocks and bonds of other co.)
(e.g.) Declared property dividend of xyz stock with fair value
$7,000 and book value $4,500. Distributed later.
When declared:

(i) Adjust the book value of asset to FV

Or

(ii) Record the dividend

When distributed:

(C) Liquidating dividends: When dividends exceed RE

(Declared and paid dividend of $1,200 when the balance of RE
was $900)

(D) Stock dividends

1) Small stock dividends (less than 25%)
(e.g.) Declared and distributed a 10% stock dividend (100,000
shares) when the share price was $5. The par value was $1.

2) Large stock dividends (from 25% up)

(e.g.) Declared and distributed a 100% stock dividend
(1,000,000 shares) when the share price was $5. (par value $1).

3) Stock splits:

No entry (par value will change)

Ch 16 Dilutive Securities
(1) Convertible bonds: Bonds that can be converted to common
stock in a specified time period at a specified rate
At issue: Record like non-convertible bonds
At conversion: Book value method
(e.g.) Companys $100,000 bonds had discount of $9,000 when
they were converted to 5,000 common shares (par value $2).
The share price at that time was $21.

If par value of common stock is greater than the book value of

bonds, charge (debit) RE or Add p-i capital.
(2) Convertible preferred stock:
At issue: Record like non-convertible preferred stock
At conversion: Book value method
Debit preferred stock and the related P-i c ieop
Credit CS at par value
The difference is P-i c ieop (credit); RE or P-i c (debit).

(3) Detachable stock warrants issued with stocks or bonds

(Non-detachable warrants are debts like convertible bonds)

Stock warrants are right to purchase common stock at specified

price in a specified period.
At issue: Since the two securities can be used separately, the
proceeds from the issue must be allocated to the two securities.
Use Proportional method if prices of both are known.
Use Incremental method if only one price is known.
(e.g.) On 10/1/08, $400,000, 10-year, 10% bonds were issued at
120. The bonds were issued with 4,000 detachable stock
warrants with strike price $40. At that time, the price of the
stock was $46 per share, the price of similar bonds without
warrants was 110, and the price of a similar stock warrant was
$15. Journalize the issuance of the bonds with warrants.
Use the proportional method since both prices are available.

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(e.g.) Do the same assuming that the price of bonds without

warrants is not available.
Use the incremental method because only one price is known.

Stock Compensation Plans

(1) Stock option plan
A. Valuation of stock option granted and expense allocation
Stock options are valued at the fair value at the grant date
(e.g.) On 1/1/13, Company granted stock options to purchase
10,000 common shares (par $20) to company executives. The
option price (or exercise price or strike price) was $50 and the
stock price at that time was $50 and the price of a similar stock
option was $6.The stock options are exercisable from 1/1/16 to
12/31/16 and are considered as compensation for the period
1/1/13 12/31/15.
1/1/13 No entry [Simply calculate the total value of the grant
as $6 x 10,000 = $60,000]

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B. Expensing of stock option grant

The same at 12/31/14 and 12/31/15.

C. Exercise of stock options
(e.g.) 8,000 of the above stock options were exercised on
11/30/16 when the stock price hit $55.

D. Expiration of stock options

(e.g.) The remaining 2,000 stock options expired on 12/31/16
when the stock price was $48.

(2) Restricted stock

Company grants employee stock that is transferable only after a
period of time (service period). This has recently become more
popular than stock option compensation.

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(e.g.) On 1/1/13, Company granted 5M common shares (par

value $1) to employees with the vesting date 12/31/16. The
stock price at the grant date was $12.

The same at 12/31/14, 12/31/15, and 12/31/16

If employees quit before the end of the service period, the grant
is forfeited and the entries are reversed (including compensation
expense).

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Exercise (SE)
1. Prepare journal entries for Kyle Company to record the
following events or transactions. Kyles common stock has par
valueof$1.
A.On4/15/13Kylepurchased60,000treasurysharesfor$570,000
cash. At that time Paidin Capital from Treasury Stock had a
balance of $150,000. On 9/24/13 the company sold all 60,000
sharesfromtheabovefor$790,000cash.Journalizethe4/15and
9/24transactionsusingthecostmethod.
B.On12/18/13 Kyledeclaredandpaida 10%stockdividend.At
that time, Kyle had 1,000,000 common shares outstanding and
Kylessharewastradedfor$13pershare.
2. On 1/1/13 Webb Company granted stock options for 1,000,000
commonsharestoemployees.Theoption(strike)pricewas$35per
share,themarketpriceofstockatthattimewas$40pershare
(with par value of $10 per share), and the market price of a
similaroptionwas$8.Theoptionsweretoexpireatyearendand
wereconsideredcompensationforthecurrentyear.On12/29/13,
all1,000,000optionsabovewereexercisedwhenthestockprice
was$37pershare.Journalizetherelatedtransactionsin2013.

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Ch 19 Earnings Per Share

Dual presentation

Basic EPS the best-case (no) dilution

Diluted EPS the worst-case dilution

(I) Basic EPS

Basic EPS = (NI preferred dividends) Weighted average
number of common shares outstanding
Calculating WA#CSO
(e.g.)
1/1
5/1
7/1
10/1

# of shares outstanding
Beginning # of shares
Issued 30,000 shares
Purchased 10,000 treasury shares
2:1 stock split

100,000
130,000
120,000
240,000

Compute the weighted average number of common shares

outstanding as of 12/31.

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(II) Diluted EPS

If-converted method: EPS is computed assuming that all
dilutive securities were converted as of the beginning of the
fiscal year (as of the issue date if issued this year).
Anti-dilutive securities are excluded in computing EPS.
(NI Pref div)
+ (Effects of dilution on NI Pref div)
Diluted EPS =
(WA# of CS outstanding)
+ (# of CS to be issued on dilution)

(1) Convertible Bonds

Effect of conversion on (NI Pref div)
= Interest expense (1 tax rate)
Effect on denominator = # of CS to be issued on conversion
(2) Convertible Preferred Stock
Effect of conversion on (NI Pref div)
= Dividends for convertible pref stock
Effect on denominator = # of CS to be issued on conversion

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(3) Stock options and warrants

Use Treasury stock method: Assume that stock options were
exercised at the beginning of the year (at the issue date if issued
this year) and the cash proceeds were used to purchase treasury
stock evenly during the year. If the # of CS increases as a result,
the increase is the denominator effect. If the # of CS decreases,
ignore the stock options because they are anti-dilutive.
Effect of exercise on (NI Pref div) = 0
Effect on denominator = # of CS to be issued on conversion
(record only when it is positive)
(e.g.) At 12/31 there are 10,000 stock options with strike price
$30. The average stock price during the year was $40.
Net increase in # of CS = # of CS issued when exercised
(Cash proceeds from exercise average stock price)
= 10,000 (10,000 $30 $40)
= 10,000 (1 $30/$40) = 2,500 (the effect on denominator)
Formula: The denominator effect
= # of stock options [ 1 (strike price / stock price)]
If the average stock price is less than strike price, then the stock
option is anti-dilutive and is excluded.
(4) Keep reducing EPS by combining the lowest EPS security
until the minimum is reached Diluted EPS

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Steps to compute Diluted EPS

a
x
1. Compute the Basic EPS and write it in the form of b
.

2. For each dilutive security, compute the numerator effect and

c
y
the denominator effect and express them as d
.

3. Arrange them in the order of their values (y), the lowest one
first.
4. If the value of the lowest one is less than the Basic EPS,
ac
z
b

d
combine it to form a new EPS
.

5. If the value of the next lowest one is less than the value of the
new EPS (z), combine it to form a new EPS.
6. If the value of the next lowest one is greater than or equal to
the value of the new EPS (z), do not combine it and z is the
Diluted EPS.

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Exercise (SE)
For the fiscal year 2013 Brown Company had $200,000,000 net
incomeandpaid$36,400,000aspreferreddividends.Thetaxrate
was 35%. The following is the information about the number of
commonsharesduring2013.
1/1
Thenumberofcommonsharesoutstandingwas53,000,000.
7/1 Issued7,000,000commonshares
8/1 20%stockdividend
12/1
Purchased3,000,000treasuryshares
At12/31/13Brownhadthefollowingsecuritiesoutstanding:
(1)$50M,6%,10yearbondswhichwereissuedatparon7/1/08
andconvertibleto2,000,000commonsharesafter7/1/13.
(2)5,000,000preferredshareswhichwereissuedon1/1/11 and
canbeconvertedto1,000,000commonsharesafter1/1/11.During
thisyeardividendsof$2,400,000werepaidtothesepreferred
shares.
(3) 3,000,000 stock options with strike price $22, which were
issuedon4/1/13 andcanbeexercisedafter4/1/17.Theaverage
marketpriceofstockduring2010was$24pershare.

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