BCM 221: ACCOUNTING FOR LIABILITIES

SEPT DEC 2022

CONTINOUS ASSESSMENT TEST

Instructions

1. Attempt all questions

2. Show your workings

a) Examine any four costs involved in issuing stock/equity. (4 Marks)

b) Seal Corporation, which closes its books each year on dec 31, receives its
property tax bill in May each year. The fiscal year for the city in which
seal corp. is located begins on May 1 and ends on the following April 30.
Property taxes of sh 36,000 are assessed against seal corp property on
January 1, 2018. And become a lien on May 1, 2018. Tax bills sent out
in May and are payable in equal instalments on July 1 and September 1.
Show the entries to record the liability, monthly tax charges and the tax
payments for taxes becoming a lien on may1, 2018. (6 Marks)

a) Rathbone Co. issues 2,000 convertible bonds at the start of 2012. The
bonds have a three-year term, and are issued at par with a face value of
KSh.1,000 per bond, giving total proceeds of KSh.2,000,000. interest is
payable annually in arrears at a nominal annual interest rate of 6%.
Each bond is convertible at any time up to maturity into 250 common
shares. When the bonds are issued, the prevailing market interest rate
for similar debt without conversion options is 9%. At the issue date, the
market price of one common share is KSh.3. The dividends expected
over the three-year term of the bonds amount to 14c per share at the end
of each year. The risk-free annual interest rate for a three-year term is
5%. Determine the value of the equity component in the bond . (5
Marks)
 MANAGEMENT UNIVERSITY OF AFRICA

STUDENT’S NAME: SALOME WANJIRU

ADMISSION NUMBER: BCOM/22/00190/2/21

UNIT TITLE: ACCOUNTING FOR LIABILITIES

UNIT CODE: BCM 221

CONTINOUS ASSESSMENT TEST ( CAT)

SEMESTER: SEPTEMBER - DECEMBER, 2022

 ANSWERS

c) Examine any four costs involved in issuing stock/equity. (4 Marks)

The cost of equity is the return that a company requires to decide if an

investment meets capital return requirements. Firms often use it as a
capital budgeting threshold for the required rate of return.

There are a variety of fees – or costs – that a company incurs when

issuing new securities into the market on behalf of their company.
Among the costs are:

1. Clerical fees

Clerical fees refer to costs incurred for preparing the forms that must be
filled out and filed when new securities are introduced. There are also
forms for registering said securities, which require specific information
about the company. Typically, these are costs incurred by third-party
accountants or other professionals with professional knowledge.

2. Filings with the Securities and Exchange Commission

Separate from the clerical filing fees, new securities must be registered
with the Securities and Exchange Commission (SEC) on behalf of the
company. The fees associated with the SEC filings are a part of equity
issuance fees.

3. Underwriting fees

Individuals – or more often, companies such as an investment bank –

who act as middlemen, getting new securities to the appropriate
investors, charge a commission (a fee) for both finding appropriate
investors and for finalizing the sale of the securities to the investors.

4. Marketing costs

There are costs associated with the marketing of new securities which
involve advertising and promoting the securities being introduced into
the market. Promotional activities are a key component for securities
because a successful marketing campaign is what helps underwriters
 find the right investors for the securities and enable the securities to be
sold successfully at the highest possible price.
Accounting for Issuance Fees

There two basic ways that issuance fees can be accounted for, namely:

1. As a reduction to paid-in capital

Equity issuance fees may be listed as a reduction of paid-in capital. The

reduction is taken from paid-in capital (the amount paid by investors
during common or preferred stock issuance) that exceeds the par value
of the security. This accounting approach is used by those who believe
that issuance fees shouldn’t be considered part of the company’s regular
operations, but instead, are part of its financing activities.

2. As part of organizational costs

The second way that equity issuance fees can be accounted for is as part
of a company’s organizational costs. With this method of accounting,
issuance fees are viewed as intangible assets. This means that the fees
(costs) may be expensed over the course of time. However, they must be
entirely written off within a 40-year limit. The theory behind this
accounting method is that the fees created an ongoing benefit for the
issuer.

d) Seal Corporation, which closes its books each year on dec 31, receives its
property tax bill in May each year. The fiscal year for the city in which
seal corp. is located begins on May 1 and ends on the following April 30.
Property taxes of sh 36,000 are assessed against seal corp property on
January 1, 2018. And become a lien on May 1, 2018. Tax bills sent out
in May and are payable in equal instalments on July 1 and September 1.
Show the entries to record the liability, monthly tax charges and the tax
payments for taxes becoming a lien on may1, 2018. (6 Marks)
SOLUTION

• 1st tax payment on July 1, 2008

Property taxes payable 6,000

Prepaid property taxes 12,000
Cash 18,000

• Monthly expense accrual for July 31, and August 31, 2008

Property tax expense 3,000

Prepaid property taxes 3,000

• 2nd tax payment on September 1, 2008

Prepaid property taxes 18,000

Cash 18,000

• Monthly expense accrual for Sept 30 through April 30, 2009

Property tax expense 3,000

Prepaid property taxes 3,000

Prepaid property taxes of sh 12,000 on July 1 represents a 4-month

prepayment and sh 18,000 on September 1 represents a 6 month
prepayment

At December 31, the account has 4 month of unexpired tax

 C) Rathbone Co. issues 2,000 convertible bonds at the start of 2012. The
bonds have a three-year term, and are issued at par with a face value of
KSh.1,000 per bond, giving total proceeds of KSh.2,000,000. Interest is
payable annually in arrears at a nominal annual interest rate of 6%.
Each bond is convertible at any time up to maturity into 250 common
shares. When the bonds are issued, the prevailing market interest rate
for similar debt without conversion options is 9%. At the issue date, the
market price of one common share is KSh.3. The dividends expected
over the three-year term of the bonds amount to 14c per share at the end
of each year. The risk-free annual interest rate for a three-year term is
5%. Determine
the value of the equity component in the bond . (5 Marks)

SOLUTION

Maturity value of bonds payable 2,000,000

Present value of $100,000 due in 3 years at
Interest payable annually
FV (PVF 6%); (2,000,000 x 0.6) 12,000
Present value of 4,000 interest payable
Annually for 3 years at 6% annually
Proceeds from sale of bonds (4,000,000)
**THE END**