1.

On December 31, 2019, Gaiety Company issued 5,000 of its 8% 10-year P1,000 face value
bonds with detachable warrants at 110. Each bond carried a d e t a c h a b l e w a r r a n t for 10
ordinary shares of P100 par value at a specified option price of P120. Immediately after
issuance, the market value of the bonds without warrants was P4,800,000 and the market value
of the warrants was P1,200,000. On December 31, 2019, what amount should be reported as
bonds payable?
Answer:
P 4,800,000.
-Issue price of bonds payable is equal to the market value of the bonds without warrants.

2. On December 31, 2019, Gallant Company issued P8,000.000 of 12% bonds payable
maturing in 5 years. The bonds pay interest semiannually. The bonds include
n o n d e t a c h a b l e w a r r a n t s giving the bondholders the right to purchase 16,000 P100 par
value ordinary shares for P150 per share within the next three years. The bonds and warrants
were issued at 120. The value of the warrants at the time of issuance was P1,500,000. The
market rate of interest for similar bonds without the warrants is 10%. The PV of 1 at 5% for ten
periods is .61, and the PV of an ordinary annuity of 1 at 5% for ten periods is 7.72. On
December 31, 2019, what amount should be reported as increase in shareholders’ equity?
Answer:
Present Value of 1 (P 8,000,000 x .61) P 4,880,000
Present Value of annuity (P 480,000 x 7.72) 3,705,600
Total Present Value P 8,585,600

Issue price of bonds with warrant (P 8,000,000 x 120%) P 9,600,000

Present value of bonds payable 8,585,600
Equity Component P 1,014,400

3. Habitable Company issued 5,000 convertible bonds on January 1, 2019. The bonds have a
three-year term and are issued at 110 with a face value of P1,000 per bond. Interest is payable
annually in arrears at a nominal 6% interest rate. Each bond is convertible at anytime up to
maturity into 100 shares with par value of P5. It is reliably determined that the bonds would
sell only at P4,600,000 without the conversion privilege. What is the equity component of the
issuance of the convertible bonds on January 1, 2019?
Answer:

Issue Price of bonds with warrant

(5000 x P 1000 = P 5,000,000 x 110) P 5,500,000
Market value of bonds without warrants 4,600,000
Residual amount allocated to warrants-equity component P 900,000

4. On July 1, 2019, after recording interest and amortization. Hackneyed Company converted
P5,000,000 of its 12% convertible bonds into 50,000 shares of P50 par value. On the
conversion date, the carrying amount of the bonds was P6,000,000, the market value of the
bonds was P6,500,000, and the share was publicly trading at P150. The entity incurred
P100,000 in connection with the conversion. When the bonds were originally issued, the equity
component was recorded at P1,500,000. What amount of share premium should be recorded as
a result of the conversion?
Answer: P4,900,000
Carrying amount of the bonds P 6,000,000
Equity Component 1,500,000
Total consideration P7,500,000
Par Value of shares issued (2,500,000)
Share Premium from conversion P5,000,000
(100,000)
Share Premium P4,900,000

5. On January 1, 2019, X Company borrowed P1,000,000 in the form of a two-year note

payable with an interest rate of 12%. Interest is payable every December 31. The principal is
payable on December 31, 2020.

6. On January 1, 2019, Roselie Company purchased inventory with payments in installment of

P200,000 per year for two years to be paid on January 1, 2020 and January 1, 2021. The cash
price is P338,000 and the effective rate is 12%.
a. Interest expense 2019
Answer: P 40,560
P338,000x12%=P40,560
b. Interest payable 2019
Answer: P 40,560

7. On January 1, 2019, Probono Company purchased land with payments in installment with a
down-payment of P100,000 and a payment of P200,000 per year for two years to be paid each
December 31. The cash price is P438,000 and the effective rate is 12%.
a. Amortization table
Answer:
Solution:
Date Payment Interest Expense Principal Present Value
Jan.1,2019 P338,000
Jan.1,2020 P200,000 P40,560 P159,440 P178,550
Jan.1,2021 P200,000 P 21, 427.20 P 178, 572.80 -

b. How much is the interest expense for 2020?

Answer: Interest expense for 2020 is P21,427.20 .

8. Sacrilege Company frequently borrows from the bank in order to maintain sufficient
operating cash. The following loans were at a 12% interest rate, with interest payable at
maturity. The entity repaid each loan on its scheduled maturity date.
Date of loan Amount Maturity date Term of loan
11/1/2019 500,000 10/31/2020 1 year
2/1/2020 1,500,000 7/31/2020 6 months
5/1/2020 800,000 1/31/2021 9 months
The entity records interest expense when the loans are repaid. As a result, interest expense of
P150,000 was recorded in 2020. If no correction is made, by what amount would 2020 interest
expense be understated?
Answer:

1/1/20 – 10/31/20 (P 500,000 x 12% x 10/12) P 50,000

2/1/20 – 7/31/20 (P 1,500,000 x 12% x 6/12) 90,000
5/1/20 – 12/31/20 (P 800,000 x 12% x 8/12) 64,000
Total Interest Expense for 2019 P 204,000
Recorded Interest expense in 2019 ( 150,000)
Understatement Interest expense P 54,000

9. Sacrosanct Company offered a contest in which the winner would receive P1,000,000,
payable over twenty years. On December 31, 2019, the entity announced the winner of the
contest and signed a note payable to the winner for P1,000,000, payable in P50,000
installments every January 1. Also on December 31, 2019, the entity purchased an annuity for
P418,250 to provide the P950,000 prize remaining after the first P50,000 installment, which
was paid on January 1, 2020.
On December 31, 2019, what amount should be reported as note payable-contest winner, net of
current portion?
Answer: P950,000

NP remaining prize (NC) P 950,000

Contest prize (418,250)

Discount on NP P 531,750

Contest Prize expense P 418,250

Discount on Note Payable 531,750
Note Payable - current P 950,000
#

Contest Prize expense P 50,000

Note Payable – current P 50,000
#

In the 2019 income statement, what amount should be reported as contest prize expense?
Answer:

Contest Prize expense 2019 : (P 418,250 + 50, 000) = P 468,250

1. What is the proper treatment of compound financial instrument?

a. The liability and equity component shall be accounted separately in accordance
with the substance of the contractual arrangement and the definition of a financial
liability and an equity.
b. The whole instrument shall be treated as a financial liability or equity instrument at
the option of the holder.
c. The whole instrument shall be treated as a financial liability or equity instrument at
the option of the issuer.
d. The whole instrument shall be treated as a financial liability.
2. When bonds payable are issued with detachable share warrants, how shall the issue price be
allocated?
a. The issue price shall be allocated pro-rata to liability component and equity
component based on their relative fair value.
b. The issue price shall be allocated pro-rata to liability component and equity
component based on their book value.
c. The issue price shall be allocated first to the fair value of equity component and the
remainder of issue price to liability component.
d. The issue price shall be allocated first to the fair value of liability component ex-
warrant and the remainder of issue price to equity component.
3. When bonds payable are issued with non-detachable share warrants, how shall the issue
price be allocated when the fair market value of bonds ex-warrants is unknown?
a. The issue price shall be treated wholly as bonds payable.
b. The issue price shall be treated wholly as share warrants.
c. The issue price shall be allocated first to the fair value of equity component and the
remainder of issue price to liability component.
d. The issue price shall be allocated first to the liability component as the present value
of principal bond liability plus the present value of future interest payments using
effective interest rate for similar bonds without the warrants and the remainder of
issue price to the share warrants.
PART I
Parker Co. $50 par value common stock has always traded above par. During year 1, Parker had
several transactions that affected the following balance sheet accounts:
I. Bond discount
II. Bond premium
III. Bond payable
IV. Common stock
V. Additional paid-in capital
VI. Retained earnings

For each of the following items, determine whether the transaction Increased, Decreased, or had
No effect for each of the items in the chart.

Bond Bond Bonds Common Additional Retained

discount premium payable stock paid in earnings
capital
1. Parker issued Increased No Effect Increased No Effect No Effect No Effect
bonds payable with a
nominal interest rate
that was less than the
market rate of
interest.
2. Parker issued No Effect Increased Increased No Effect No effect No Effect
convertible bonds,
which are common
stock equivalents,
for an amount in
excess of the bonds’
face amount.
3. Parker issued No Effect Decreased Decrease Increased Increased No Effect
common stock when d
the convertible
bonds described in
item 2. Were
submitted for
conversion. Each
$1,000 bond was
converted into
twenty common
shares. The book
value method was
used for the early
conversion.
4. Parker issued No Effect No Effect Increased No Effect No Effect No Effect
bonds with
nondetachable
warrants for an
amount equal to the
face amount of the
bonds. The stock
warrants do not have
a determinable
value.
5. Parker issued Increased No Effect Increased No Effect Increased No Effect
bonds, with
detachable stock
warrants, for an
amount equal to the
face amount of the
bonds. The stock
warrants have a
determinable value.
6. Parker redeemed a Decreased No Effect Decrease No Effect No Effect Decreased
bond issued at 8% at d
a discount for an
amount that was
102% of face value.
7. Parker issued No Effect Increased Increased No Effect No Effect No Effect
bonds payable with a
nominal rate of
interest that is higher
than the market rate.
8. Parker called a No Effect Decreased Decrease No Effect No Effect Increased
bond that was issued d
at
105 at a time when
the market value of
the bond was less
than its carrying
value.