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Complex Financial Instruments - Chapter 16 - Assignment Set: Question #1

The document discusses employee stock options and convertible bonds. It provides details on stock options granted to two employees and entries related to compensation expense and options forfeited. It also discusses the issuance of convertible bonds by a company, including entries for issuance, interest expense, and potential conversions. The last question discusses whether hedge accounting is required for a foreign exchange transaction.

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16 views

Complex Financial Instruments - Chapter 16 - Assignment Set: Question #1

The document discusses employee stock options and convertible bonds. It provides details on stock options granted to two employees and entries related to compensation expense and options forfeited. It also discusses the issuance of convertible bonds by a company, including entries for issuance, interest expense, and potential conversions. The last question discusses whether hedge accounting is required for a foreign exchange transaction.

Uploaded by

hthacker11
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Complex Financial Instruments – Chapter 16 – Assignment Set

Question #1

Morning Ltd. had issued employee stock options to only two employees with the
following details:
Market Value of Fair Value of Vesting Date
Employee Date Stock Number of Stock the Underlying Stock Options of Options Expiry
Name Options Options Option Common Share at Date of Date of
Granted Exercise at Date of Grant Grant Options
Price
Jonathan July 1, 2016 1,000 $5.00 $5.00 $12,000 July 1, 2020 Dec. 31,
2022
Elizabeth July 1, 2016 3,000 $4.00 $6.00 $36,000 July 1, 2019 Dec. 31,
2021

Jonathan quit working at Morning Ltd. on June 30, 2018. Elizabeth continues to
work for Morning Ltd.

Required #1:
What is the impact of the above on the reported compensation expense for the year ended
December 31, 2018? (one figure only; no entries required here)

Year 2018 compensation


Elizabeth from Jan-Dec : 12*(36000/36)=$12000
Jonathan (Jan-June): 6*$250=$1500
Reverse 2 years*$250=$(6000)
Net Compensation Expense= $7,500

Required #2:
Prepare all applicable entries for the stock option plan for the year ended December 31,
2018. Where applicable the effect of the two employees can (but not required) be
combined as one entry; it is not necessary to provide all entries for each employee.
Compensation from Jan to June for Elizabeth and Jonathan= 1250*6=$7,500

Dr Compensation expense $7,500


Cr Contributed surplus, stock option plan $7,500

Entry due to Jonathan’s Departure


Dr Contributed surplus, stock option plan $6,000
Cr Compensation expense $6,000

Elizabeth compensation from July to December


Dr Compensation expense $6,000
Cr Contributed Surplus $6,000

Required #3:
Elizabeth left the company on July 1, 2020 and had not exercised ½ of her option
entitlement. Provide any applicable entry for the year ended December 31, 2020.

The unexercised entitlement for Elizabeth is $18,000, which is 0.50 of unexercised option
of FV $36,000

Dr Contributed surplus, stock option plan $18,000


Cr Contributed surplus, unexercised employee stock options $18,000

Page 1 of 4 – 2022Winter - Student


Complex Financial Instruments – Chapter 16 – Assignment Set

Question #2:

Okanagan Valley Limited (OVL), a December 31 year end publically traded company,
issued convertible bonds on January 1, 2017 maturing on December 31, 2026 when
the market rate was 10%. The bond terms stated:

“$7,500,000 of 8% subordinated convertible debentures payable, interest payable


semi-annually, (June 30, December 31) convertible at the investor’s option until or
at maturity into Class A common shares of the company at a rate of 65 shares for
each $1,000 bond issued.”

The bonds were issued for net proceeds of $7,200,000. Independent option pricing
models indicated that the value of the conversion right approximated $643,000. OVL
applies the effective interest rate method.

Requirement #1:
Record the issuance of the bonds; with supporting computations.
N=20, i=5, PMT= $300,000, FV= $7,500,000 PV= 6,565,334

Dr Cash $7,200,000 (given)


Dr Discount on Bonds payable $934,666 ($7,500,000-$6,565,334)
Cr Bonds payable $7,500,000
Cr Common Stock Conversion rights $634,666 ($7,200,000-
$6,565,334)

Page 2 of 4 – 2022Winter - Student


Complex Financial Instruments – Chapter 16 – Assignment Set

Requirement 3
Record the interest expense for the six months ended June 30, 2017
Dr Interest expense $328267 ($6,565,334*5%)
Cr Discount on bonds payable $28,267 (difference)
Cr Cash $300,000 ($7,500,000*4%)

Requirement 4
Prepare the entry(ies) if, at maturity date (after last interest payment), all
bondholders exercised their conversion right.

Dr Bonds payable $7,500,000


Cr Cash $7,500,000

Dr Common share conversion rights $634,666


Cr Contributed surplus: lapse of conversion rights $634,666

Requirement 5

Prepare the entry(ies) if, at maturity date (after interest payment), no bondholders
exercised their conversion right.

Dr Bonds payable $7,500,000


Dr Common Shares conversion rights $634,666
Cr Common shares, no-par $8,134,666

Requirement 6
Prepare the entry(ies), if, on January 1, 2023, after the interest payment, 20% of
the bondholders exercised their right to convert their bonds to shares; this was the
first conversion exercise.

N=8; PMT=$300,000; FV=$7,500,000; i=5%


Carrying Value of the bond issue on January 1, 2023 $7,015,259
Par Value is $7,500,000
So, the unamortized discount is $7,500,000-$7,015,259= $484,741

Dr Bonds payable $1,500,000 (20%*7,500,000)


Dr Conversion Rights $126,933 (20%*634,666)
Cr Discount on bonds payable $96,948 (20%*484,741)
Cr Common shares (attributed value) $1,529,985

Page 3 of 4 – 2022Winter - Student


Complex Financial Instruments – Chapter 16 – Assignment Set

Requirement 7
If this were a Private Enterprise company adopting Private Enterprise (ASPE)
standards what alternative reporting of this bond issue is available? Provide the
related entry upon issuance.

Dr Cash $7,200,000
Dr Discount on Bonds payable $300,000
Cr Bonds Payable $7,500,000

Question #3

Sea-to-Sky Investments (SSI) has purchased CDN$6,000,000 of product from a


Swiss company and the transaction is denominated in Swiss Francs (SFR). SSI
anticipates payment in 90 days under the agreed terms of settlement. SSI holds in
its investment portfolio a large block of Nestle Company shares. Nestle is based in
Vevey, Switzerland and SSI’s holdings are denominated in Swiss Francs and
accounted for as FV-OCI. SSI wishes to minimize in its operating results any foreign
exchange exposure arising from the account payable due in 90 days.

Required: Does the above situation require the adoption of Hedge Accounting?
Why or why not; you must explain adequately?

- Hedge Accounting is specialized, optional and is an accounting policy choice.


- This ‘sub-set’ of accounting is required mainly because of the mixed
measurement model comprising the financial statements; cost, amortized
cost and fair value where, depending on the designation, gains or losses can
be recorded either in normal operating income or as Other Comprehensive
Income (OCI). This situation can cause “mismatches” in the income statement
reporting of the hedged item and the hedge itself. Hedge accounting remedies
such mismatches.
- Based on the above scenario, Hedge accounting adoption is required as there
are mixed measurements involved and the transaction is complex in nature.
SSI’s holdings are accounted for Other Comprehensive Income (OCI), where
its purchase of Product cannot be offset from the investment portfolio as that
can cause mismatches in the income statement. Therefore, Hedge accounting
is required to rectify such mismatches.

Page 4 of 4 – 2022Winter - Student

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