Bonds

Question 1

Define convertible bonds

Answer 1

Bonds that may be converted at the option of the holder into other securities (usually common stock) of the issuing company. The conversion usually must take place within a specified time period and is bases on a state conversion ratio.

Question 2

What is the conversion ratio for convertible bonds?

Answer 2

It is the number of shares of common stock or other security the bondholder is entitled to receive for each bond converted

Question 3

Theoretically, the conversion feature of convertible bonds has an economic value in that the bond should sell at a higher price with the conversion feature than without it. Does FASB require a separation of the convertible debt and the conversion feature?

Answer 3

no

Question 4

Theoretically, the conversion feature of convertible bonds has an economic value in that the bond should sell at a higher price with the conversion feature than without it. Does IFRS require a separation of the convertible debt and the conversion feature?

Answer 4

Yes

Question 5

The conversion of debt into common stock by the holder poses a problem to the issuer of which basis to use to record the conversion. What are the 2 acceptable alternative methods or bases?

Answer 5

1. carrying amount of the debt converted (book value method). Chief argument for book value is it is not appropriate to recognize gains/losses arising from the transactions in a company’s own stock. It is a substitution of one form of security for another
2. FV of the stock issued (fair value method). Recognition of gain/loss is consistent with the accounting treatment required for early extinguishment of debt. It is also consistent with the idea that an exchange has taken place so FV should be used.

Question 6

What method is most widely used in practice for convertible bonds?

Answer 6

book value

Question 7

An induces conversion of debt is one in which the issuer of the debt does one of two things. What are they?

Answer 7

1. changes the conversion privileges in a convertible debt instrument OR
2. pays additional consideration to convertible debt holders for the purpose of inducing prompt conversion of the debt to equity securities

Question 8

The question arises s to whether the induced conversion of debt should be accounted for in what 2 ways?

Answer 8

1. as other conversions (with no gain/loss recognized) or

2. extinguishment of debt (with gain/loss recognized)

Question 9

FASB ASC 470-20-40-16 specifies that the debtor enterprise should recognize an expense equal to the fair value of all securities and other consideration transferred in the transaction in excess of the fair value of securities issuable pursuant to the original conversion terms. How should the expense be reported?

Answer 9

no as an extraordinary item.

Question 10

What are the 3 characteristics of specific unconditional purchase obligations as addressed in FASB ASC 440-10-50-2?

Answer 10

1. Has a remaining term in excess of one year
2. was negotiated as part of arranging financing for the facilities that will provide the contracted goods/services or for cost related to those goods/services
3. in non-cancelable or cancelable only:
   a. on the occurrence of some remote contingency
   b. with the permission of the other party
   c. if a replacement agreement is signed between the same parties
   d. on payment of a penalty in an amount such that continuation of the agreement appears reasonably assured

Question 11

If unconditional purchase obligations have not been recognized as a liability on the balance sheet, the purchaser must disclose what 4 things?

Answer 11

1. the nature and term of the obligation(s)
2. the amount of the fixed and determinable portion of the obligation(s) as of the date of the latest BS presented in the aggregate and, if determinable, for each of the 5 succeeding fiscal years
3. the nature of any variable components of the obligation(s)
4. the amounts purchased under the obligation(s) for each period for which an income statement is presented

Question 12

Is present value of unrecorded unconditional purchase obligations required?

Answer 12

no but is encouraged

Question 13

If present value is disclosed for unrecorded unconditional purchase obligations, what is the discount rate?

Answer 13

it is the initial interest rate of the borrowing that financed the facility that will provide the contracted goods/services, if known

Question 14

If present value is disclosed for unrecorded unconditional purchase obligations and the initial interest rate of the borrowing is unknown, what is the discount rate? 

Answer 14

the purchaser’s incremental borrowing rate

Question 15

When unconditional purchase obligations are recorded by the purchaser as an asset and a related liability, what must be disclosed?

Answer 15

aggregate amount of payments for such unconditional purchase obligations for each of the 5 years following the date of the latest BS presented

Question 16

What are the 2 required disclosures for all long term obligations for each of the 5 years following the date of the latest BS presented?

Answer 16

1. combines aggregate amount of maturities and sinking fund requirements for all LT borrowing
2. the amount of redemption requirements for all issues of capital stock that are redeemable at fixed or determinable prices on fixed or determinable dates, separately by issue or combined